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Stagflation is possible, says investing legend Bill Gross

Don't rule out an economic period of stagflation, warns investing legend Bill Gross.

“I don't think 7% inflation or more, which we have now, is really our future. A lot of things will reverse like housing prices, oil prices, and used car prices. I think we're looking at 4% to 5% inflation for the next several years. So that's stagflation. But it's not a stagflation of the early 80s," said the Pimco founder on the latest episode of Yahoo Finance Presents.

Stagflation is characterized by a period of slow economic growth, increased joblessness and rising inflation.

To be sure, there are indications of this economic backdrop beginning to form.

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The Consumer Price Index (CPI) rose by 7.9% in February, marking the fastest pace of annual inflation in 40 years amid a push higher in rent, food and used car prices.

Meanwhile, oil prices have come off their highs of around $140 a barrel seen at the start of the Russia-Ukraine war, but remain uncomfortably high. Brent crude oil hovered at $105 a barrel on Tuesday as tensions overseas remained elevated.

As prices have climbed throughout the economy, the Federal Reserve has begun to hike interest rates to cool things down. In turn, that has sent interest rates rising (see mortgage rates) — sparking many to worry about a sharp economic slowdown this year that leads to the joblessness inherent in a stagflationary backdrop.

Bill Gross, co-founder and co-chief investment officer of Pacific Investment Management Company (PIMCO), speaks at the Morningstar Investment Conference in Chicago, Illinois, June 19, 2014. Gross, who runs the world's largest bond fund, took the stage at the investment conference wearing sunglasses and seeming self-conscious about his image, lacing his speech with references to American World War Two Gen. George Patton, hypnosis and troubled pop star Justin Bieber.    REUTERS/Jim Young  (UNITED STATES - Tags: BUSINESS)

The bond market has started to snuff this possibility out.

The spread between the 2-year and 10-year Treasury — better known as the yield curve — moved another step closer to inversion Tuesday. An inverted yield curve has often been a precursor to recessions.

When yield curve inversions happen during an interest rate hiking cycle, recessions start within 1-3 years, notes Deutsche Bank. To be more precise, they tend to occur 23 months after the first inversion.

Gross who just penned his own memoir called "I'm Still Standing: Bond King Bill Gross and the Pimco Express" doesn't rule out a recession.

"A flattening yield curve historically, at least, has portended slow growth or recessionary conditions and that's what we have [now]," Gross added.

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

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