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Inflation's Cycle: How Asset Prices React to Changing Economic Trends

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Understanding Asset Correlations
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The correlation between US stocks and Treasury bonds has changed over time, from positive in the 1970-1980's to negative in the 2000's. Inflation and asset prices also show varying relationships, with inflation becoming more cyclical in the early 2000's. This shift affects both equity and bond risk premia. The market price of inflation risk reflects the cyclical nature of inflation. The correlation between dividend yields and nominal yields changes over time due to these cyclical shifts, providing a rational explanation for the Fed-model changes.