The economy will probably overheat this summer: top strategist

With the U.S. labor market likely to bounce back strongly this summer from a surprisingly tepid April showing, the risks of an overheating economy remain on the rise.

"I do think there is a very good chance it [economy] will overheat," said Jefferies Chief Financial Economist Aneta Markowska on Yahoo Finance Live. "I expect us to reach a roughly 3% unemployment rate by the end of next year."

As Yahoo Finance's Brian Cheung explains in the latest edition of Yahoo U, there is no official economic definition for economic overheating. But one oft-cited indicator of overheating is inflation, or rising prices.

To be sure, there are numerous telltale signs of that happening in the economy currently.

The core personal consumption expenditure (PCE) price index increased faster than expected, up 3.1% in April, according to the U.S. Commerce Department. Federal Reserve officials view the index as among the best indicators of pricing pressure in the economy. The Fed believes 2% inflation is a healthy level.

On the other hand, the April Consumer Price Index (CPI) rose at the fastest pace since September 2008, clocking in with a 4.2% increase versus a year ago. And as Yahoo Finance's Sam Ro notes in the Morning Brief newsletter, consumer expectations on inflation are on an upswing.

The next brick in the overheating economy wall may come later this week via the latest read on the U.S. jobs markets.

Economists polled by Bloomberg expect the U.S. economy created nearly 700,000 jobs in May, powered by an impressive 6.4% GDP growth rate in the first quarter. The highest estimates for the employment report is 1,000,000 headline jobs being created in May, per the economists over at Desjardins Financial Group.

"Despite disappointing economic data in April, we still foresee the U.S. economy’s first quarter bloom turning into a summer boom. While real GDP remained 0.9% below its pre-COVID level in Q1, we believe it has now recouped all its recession output loss, and we expect real GDP growth around 13% annualized in Q2," said Oxford Economics chief U.S. economist Greg Daco.

The gazillion dollar question for investors is what an overheating economy would mean for equities. Thus far, stocks have been able to fend off inflation worries and fears of the Fed hiking interest rates to combat the problem. Jefferies' Markowska thinks stocks are entering a "little bit more challenging" period in large part because of where the economy is in the pandemic rebound cycle.

Many others on the Street agree with that take.

"We are expecting the stock market to keep moving higher this year and yields to move higher as increased economic growth and inflation rebound from pandemic-lows. The increase in the level of the S&P 500 won’t happen in a straight line and we are due for some type of a pullback — either a more garden-variety 5% pullback or a larger correction (say low double-digits)," said Independent Advisor Alliance Chief Investment Officer Chris Zaccarelli.

Brian Sozzi is an editor-at-large and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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