Street, Fed making this big mistake: Jim Paulsen

Window for Goldilocks sustained rally narrow: Pro
Window for Goldilocks sustained rally narrow: Pro

Wall Street investors and the Federal Reserve are both dismissing the possibility of the U.S. economy "overheating," Jim Paulsen said Thursday.

"Overheating is not about growing fast; it's about demand growing faster than weak supply," Well Capital Management's chief investment strategist said in a CNBC "Squawk on the Street" interview. "We can grow at 2 percent supply-side, but I think that Wall Street is making a big mistake, including the Fed, in assuming that we can't overheat because we're growing so slowly."

Paulsen made his remarks a day after the central bank released the minutes from its April meeting, which indicated that "a few" Fed Open Market Committee members believe the U.S. economy can handle higher rates by June.

"Many participants, however, thought it unlikely that the data available in June would provide sufficient confirmation that the conditions for raising the target range for the federal funds rate had been satisfied, although they generally did not rule out this possibility," the minutes said.

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Paulsen added that, while the path of least resistance for U.S. equities is currently higher, "the window for a 'Goldilocks' sustained rally is pretty narrow on Wall Street."

"It seems to me that, with the United States closing in on full employment, if you don't recover with margins at maximum levels, there's no recourse for earnings, but if you do recover economically and bounce, you're going to aggravate costs, [and] push interest rate pressures," he said.

Earlier this month, the Labor Department said the unemployment rate fell to a seven-year low of 5.4 percent in April, while 223,000 jobs were added.

Stocks were slightly higher midday Thursday.

—CNBC's Jeff Cox contributed to this report.