Inflation Anxiety Returns, But Price Action Remains Strong

As inflation anxiety returns to the forefront of investors' minds, the stock market continues to defy expectations, posting strong price action. This apparent disconnect between investor sentiment and market performance can be attributed to several factors, including long-term trends, central bank credibility, asset class performance, market cycles, and globalization.



Long-term Trends and Inflation Expectations

Investors distinguish between long-run trends and cyclical fluctuations in inflation and interest rates. Long-run trends represent steady-state expectations, which are reflected in asset valuations. Cyclical deviations primarily affect risk aversion, serving as proxies for changing risk aversion (Denga et al., 2022; Rapach and Zhou, 2013). For instance, the cyclical component of inflation negatively affects excess returns, indicating that these fluctuations influence risk aversion and enable the prediction of excess returns (Goyal et al., 2021).



Central Bank Credibility and Inflation Targeting

The Federal Reserve's (FED) inflation targeting policy suggests that inflation is stationary. However, this was not always the case, and the inflation targeting itself depends on the FED's credibility. The changing stock-bond correlation discussion supports this reasoning (Andersson et al., 2008; Pericoli, 2020). The negative correlation between stock and bond returns seen in the last two decades could be caused by changes in trend inflation, which affects other variables, such as interest rates (Goyal et al., 2021).

Asset Class Performance and Risk

Different asset classes perform differently under various market conditions. For example, during high-inflation periods, stocks can act as a hedge against inflation, while bonds may suffer due to unexpected inflation eating into real returns (Siegel, 2008). In the United States, stocks have historically outperformed bonds during high-inflation periods, as seen in the data provided by Jordà-Schularick-Taylor Macrohistory Database (Jordà et al., 2015).



Market Cycles and Asset Performance

Market cycles, such as bull and bear markets, rising and falling interest rates, and high and low inflation, significantly impact asset performance. For instance, during periods of rising rates and high inflation, certain assets like stocks, bonds, or commodities may perform better than others (Quantpedia, 2025). In the provided data, the US market had high excess kurtosis, indicative of fatter tails in the distribution, which could contribute to the disconnect between inflation anxiety and strong price action (Jordà et al., 2015).

Globalization and Hot Money

In emerging economies like China, hot money flows can cause significant uncertainty and impact financial markets. Massive fluctuations in hot money flows can lead to great uncertainty, causing markets to fall into long-term downturns (Zhang et al., 2019). This phenomenon can contribute to the disconnect between inflation anxiety and strong price action in global markets.



In conclusion, the apparent disconnect between inflation anxiety and strong price action in the market can be attributed to various factors, including long-term trends, central bank credibility, asset class performance, market cycles, and globalization. By considering these factors, investors can reconcile the disconnect and make informed investment decisions. As the market continues to evolve, investors should remain vigilant and adapt their strategies to capitalize on emerging opportunities.