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:
- Workers expect higher prices.
- They ask for higher wages.
- Employers raise wages but need to pay higher labor costs.
- Employers raise prices of their products.
- Workers see higher prices.
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.