Key Verification of the Dollar's Big Logic: The Next Major Drop in U.S. Stocks

Citigroup believes that the next sell-off of more than 5% in the S&P 500 index will be a litmus test for the existence of the dollar's safe-haven properties, which will in turn determine the dollar's medium-term trajectory.

According to news from the Wind Trading Desk, Citigroup's global macro strategy team stated in a report on October 15 that the recent weakness of the dollar can be attributed to two major themes: the reduction in U.S. stock allocations following the tariff shock in the second quarter, and the subsequent adjustment of hedge ratios. The core market debate is why the dollar did not exhibit safe-haven properties in April.

Currently, there are two theoretical explanations in the market: Viewpoint 1 suggests that the dollar's decline alongside U.S. stocks in April was an abnormal phenomenon caused by "self-harming" shocks, and the story of hedge ratios may have come to an end. Viewpoint 2 posits that extreme foreign investment allocations in U.S. stocks have led to a sustained positive correlation between U.S. stocks and the dollar, thus the increase in hedge ratios can continue.

Citigroup slightly leans towards the latter, with analysts believing that the breakdown of the correlation between U.S. stocks and the dollar is not a one-time event, but rather a result of foreign investors' extreme accumulation of U.S. stocks in recent years. As the artificial intelligence bubble continues to absorb global economic capital, this trend will likely continue to strengthen. The longer the positive correlation persists, the lower the benefits of dollar exposure for foreign investors, hence the motivation to continue increasing dollar hedge ratios remains.

The Citigroup team is currently slightly bearish on the dollar, but emphasizes three major catalysts for a bullish outlook on the dollar in the future:

The conclusion of the Lisa Cook Supreme Court case in January 2026 without her being dismissed, and the approval of new FOMC members;

Recovery of the U.S. labor market;

The dollar re-emerging as a safe haven in risk aversion;

Analysts emphasize that before the "Fed's dovish stance peaks and the cyclical weakness in the U.S. reaches its peak," a reversal in the dollar is unlikely (it will continue to weaken), and this turning point is expected to occur within the next three months, at which point the dollar is likely to rebound in 2026.