Top labor economist says the Fed may have just won its inflation fight, batting aside the ‘sticky’ thesis

Mohamed El-Erian, an advisor to Allianz and Gramercy and president of Queens’ College, Cambridge, said last year that inflation had become “entrenched” in the economy after Federal Reserve officials “gross mischaracterisation” of rising prices as “transitory” in 2021. And in January, he argued that inflation would get stuck around 4% this summer amid “mounting wage pressure” from consumers. Even Federal Reserve Chair Jerome Powell has said that the path to lower inflation will likely be “bumpy,” noting at a press conference last month that core inflation, which excludes more volatile food and energy prices, remains an issue.

So how do they respond to the evidence from Wednesday morning, when the consumer price index for June showed consumer inflation falling to 3%, the lowest rate in over two years, along with a slowdown in the key “core inflation?” Well, Jay Hatfield, CEO of Infrastructure Capital Management, said they’ve fallen for an “urban myth.” He told Fortune on Wednesday that “inflation is not like peanut butter. It’s not sticky. It’s caused by loose monetary policy and by supply shocks—mostly energy shocks but also food, and in this cycle, [semiconductor] chips.” 

And he was backed up by Julia Pollak, a labor market specialist who serves as chief economist for the jobs website ZipRecruiter. “Many economists argue that the last mile of inflation reduction will be the hardest, but that isn’t necessarily the case,” she told Fortune. 

Here’s why Pollak and Hatfield are looking past the sticky inflation theory—and why they think the Fed’s epic fight against the worst inflation in 40 years may already have been won.

Not looking very ‘sticky’…

Pollak broke down four main reasons why inflation may not be sticky this time around on Wednesday. 

First, she noted that the producers price index (PPI)—which measures the change in selling prices of goods and services producers—is “falling outright,” and the index is a leading indicator for consumer price inflation. Second, inflation expectations are finally dropping. Consumers’ year-ahead inflation expectations sank to 4.2% in May, according to the University of Michigan, down from a peak of 5.4% last March. Third, average weekly earnings have only risen 3.75% over the past year, which Pollak argued “is roughly consistent with 2% inflation”—the Fed’s target. And finally, the economist noted that same-store retail sales as well as spending on restaurants, hotels, and flights have all begun to drop in recent months. 

Hatfield went a step further, arguing that the fundamental thesis of “sticky” inflation—that consumers’ inflation expectations can become entrenched, leading to a wage-price spiral as workers demand pay increases to compensate for an increasing cost of living—is a type of “misinformation.” Supply shocks and loose monetary policy are the true causes of inflation in his view, and entrenched inflation expectations rarely play a role. 

“We think that the entrenched, sticky [inflation] camp is going to end up in the same waste bucket as the transitory camp,” he said, referencing the transitory or temporary inflation theory that became popular during the pandemic.

Hatfield has also argued throughout 2023 that inflation is fading far faster than Fed officials recognize because they’re looking at lagging data, particularly when measuring shelter inflation. He’s even developed his own inflation measure, CPI-R, which utilizes current housing price data to get a better estimate of the level of inflation in the economy, and it was up just 1.0% year-over-year in June. The Trueflation index, which uses real-time private sector data to measure changes in U.S. consumer prices, also fell to 2.5% last month.

“The only way the sticky theorists, including the Fed, will be vindicated is by reported numbers, not reality. The reality is we have rapidly declining inflation, some sectors, we have deflation,” Hatfield said.

Closer than we thought to the end of the Fed’s rate hikes?

Since March 2022, the Federal Reserve has hiked interest rates from near zero to a range between 5% and 5.25% in an attempt to cool the economy and tame inflation. The aggressive approach led to a wave of recession predictions from Wall Street, with experts warning that the rising borrowing costs would ultimately weigh on businesses and slow consumer spending until the unemployment rate surged. But so far, the Fed has been able to tame inflation without sparking a job-killing recession—that could mean the end of the rate hiking campaign is on the way.

“The sustained decline in inflation is encouraging news for the U.S. labor market outlook. It increases the likelihood that the Fed will be able to pause rate hikes after one final July increase, and gradually lower rates through 2024, encouraging private sector investment to pick up again,” ZipRecruiter’s Pollak said, adding that “we may be closer to the Fed’s goal than Fed members suggest.”

Hatfield, ever critical of the Fed, also said he believes officials at the central bank will raise interest rates again this month, but after that, they’ll be forced to capitulate on their “sticky” inflation theory.

“I think the evidence by September will be too overwhelming that inflation is decelerating and the economy is decelerating,” he said. “We’re growing at like 1% to 2% or something, it’s not like we’re ripping out three, four or 5% [GDP growth] numbers….so even this incompetent Fed should have it figured out by September. We think they’ll pause in September.”

Of course, not everyone believes inflation is already defeated and the Fed’s rate hiking cycle is over. Some economists point to the Atlanta Fed’s Sticky Consumer Price Index, which measures a basket of goods and services where prices tend to change slowly, as evidence that inflation is here to stay. Year-over-year sticky inflation fell to 5.8% in June. That’s down from a peak of 6.7% in February, but well above the Fed’s 2% target. 

Vanguard’s economists warned in their midyear outlook titled “Sticky Inflation Most Everywhere” last month that they believe “central banks have more work to do.” 

“We’ve always said inflation wouldn’t come down magically, even as post-pandemic supply chain issues were resolved,” Andrew Patterson, Vanguard senior international economist, wrote in the report. “The pandemic accelerated demographics-driven changes to labor markets. Strong demand for workers who can command higher pay than historical standards requires monetary policy that is clearly restrictive. The last leg of inflation reduction to central bank targets may be the most challenging.”