Inflation expectations keep rising

Both regular people and Wall Street sophisticates are ratcheting up expectations for inflation, in what wonks worry could be the start of a self-fulfilling prophecy.

Driving the news: A market-based reading of inflation expectations — often referred to as a five-year breakeven — shot to the highest level on record this week.

• This number is derived by comparing the yields on Treasury bonds to a separate Treasury that's protected against losses from inflation.
• At its current level of 3.5 percentage points, it suggests that investors now expect inflation to average roughly 3.5% a year for the next five years.

Separately, a survey from the University of Michigan on Friday showed shorter-term inflation expectations among American consumers rising to their highest level since 1981.

Why it matters: Economists theorize that there is a strong psychological component to inflation. In other words, when people expect prices to rise, they can behave in ways that actually cause prices to rise.

How it (theoretically) works:

1. Workers expect higher prices.
2. They ask for higher wages.
3. Employers raise wages but need to pay higher labor costs.
4. Employers raise prices of their products.
5. Workers see higher prices.
6. Repeat.

The bottom line: The Fed — and other central bankers — are going to view the recent rise in inflation expectations as another reason to proceed with rate increases.