Wall Street's latest dirty word—stagflation

Recession possibility to rear its head?

A tightening labor market and rising inflation against a backdrop of slowing overall growth are painting an increasingly stagflationary picture for the U.S. economy.

Stagflation, or conditions in which costs are rising but growth is not, last was seen in the 1970s, before then-Fed Chair Paul Volcker had to push the economy into recession to slay the inflation dragon.

Now, with a variety of factors coming together to show inflationary-deflationary cross currents, Wall Street is bracing for another battle.

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"During the last year, as the economy has returned closer to full employment, the core cost structure of the U.S. economy has risen more aggressively and more broadly than ever before in this recovery," Jim Paulsen, chief investment strategist and economist at Wells Capital Management, said in a report for clients. "While the U.S. is not facing runaway inflation, the concept of stagflation (i.e., rising inflation rates combined with slower real economic activity) has become much more noticeable."

Paulsen has been the Street's most emphatic messenger of the stagflation theme, contending for months that Fed policymakers are about to face a dilemma that will confound their efforts to raise interest rates and get monetary policy back on a normalized course.

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