Why Inflation Above 3% Breaks the Stock–Bond Diversification Playbook

It’s time to refresh the most important chart for any asset allocator.

This chart from the excellent Dan Rasmussen of Verdad Capital is key.

Going back almost 200 years, it’s quite evident that the stock/bond correlation isn’t negative all the times.

It’s actually often positive (!) and especially if core inflation is above 3% and particularly volatile (2022 anybody?).

That makes sense.

If core inflation is high and unpredictable, Central Banks will go a long way to tighten aggressively and get things under control again.

Central Bankers rule number 1 is to preserve credibility and therefore be able to retain control of the game.

As they tighten aggressively, bond markets will sell off and equity valuations will simultaneously take a hit: positive correlation, poor stock/bond returns.

Instead, bonds retain their amazing negative correlation to stocks only if core inflation falls predictably below 3% (green area).

And that makes sense too.

Once core inflation is within the Central Bank comfort zone, big drawdown in equities or credit markets will be seen as destabilizing for the economy and Central Banks will attach more value to their growth/labor market side of the mandate and come to the rescue.

If things get bad, bond makets will rally in anticipation of Central Bank easing: this is the negative stock/bond correlation institutional investors love so much.

So, why is this chart so relevant today?

Because trillions of wealth are invested in 60/40-like portfolios that assume the persistent and immutable negative correlation between bonds and stocks.

Yet the episodes of 2022, the tariff-tantrum of 2025 and what’s happening over the last few days beg the question.

As an allocator, do you want to go all-in assuming this negative correlation will persist? What if it doesn’t? Is your portfolio really diversified enough?

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