Sticky Inflation Is Likely if There Is No Recession

A member of Putnam's Fixed Income team since 2007, Onsel Gulbiten analyzes macroeconomic issues, including inflation, interest rates, and policy developments.

  • Cyclical factors, economic imbalances, and rising government debt may contribute to keeping inflation at 3.0%–3.5%.
  • It is highly doubtful that the Fed can maintain its hawkish inflation rhetoric when weak labor market data eventually arrives.
  • As the arithmetic of U.S. debt deteriorates, the private sector will likely demand a higher premium for holding Treasuries.

Inflation has been coming down since its peak in the summer of 2022. Because the U.S. has so far avoided a recession, soft-landing hopes have risen along with the decline in inflation. Even the Federal Reserve itself joined the bandwagon. The soft-landing view, a scenario in which inflation goes back to the Fed’s 2% target sustainably without a recession, might gather more momentum if a recession is not in sight. But there are cyclical and structural factors indicating inflation may not fall to 2% without a recession. By reviewing these factors, it becomes clear why an extended period of sticky inflation stabilizing at around 3.0%–3.5% is more likely during the Fed’s long pause, when the lagged impact of the Fed’s tightening continues to take effect.

Jobs, wages, and spending contribute to making inflation sticky

The U.S. labor market is tight. The unemployment rate is at historical lows. The overall labor force participation might look low, but this is mostly reflecting demographic changes. The prime-age labor force participation rate has risen to levels last seen at the beginning of this century. And people continue to come to the labor force. The uptick in the unemployment rate in the past couple of months has been due to increased labor force participation, not job losses. A labor market tightness indicator — the JOLTS job openings rate — has been declining but is still high. A job openings rate of 2.5% can likely bring inflation toward 2%. A drop from the current job openings rate of 5.8% to 2.5% needs to come from the demand side, as there is a limit to labor supply.

"The uptick in the unemployment rate in the past couple of months has been due to increased labor force participation, not job losses."

While a large decline in labor demand is possible as the normalization of economic activity post-Covid comes to an end, when labor supply is constrained, any extra demand for labor is likely to come with higher wages and, hence, inflation. The labor strikes making headlines more frequently of late are not a coincidence.