When the Federal Reserve is "extremely dovish", the possibility of gold and the US stock market rising together is underestimated

The Federal Reserve will hold a monetary policy meeting next week, and the market widely expects that the first interest rate cut of the year will be implemented then.

According to the Chuifeng Trading Desk, Derome Robinson, an analyst at Citigroup, and his team recently released a research report stating that during the "reflation" period when the Federal Reserve's policy stance tends to be dovish, the positive correlation between gold and risky assets such as stocks will significantly increase, and their prices often rise in tandem. However, the current market's pricing of this correlation is clearly insufficient.

According to the Fed policy stance indicator established by Citigroup, the current market pricing in the terminal interest rate is lower than the level suggested by inflation and growth indicators, indicating that the Fed's policy stance is already in a "clearly dovish" position.

Against such a macro backdrop, the historical linkage pattern between gold and risky assets is making a comeback. Citigroup's analysis shows that the six-month implied correlation between gold and risky assets such as the S&P 500 index currently reflected in the options market is far lower than what actually occurs in a similar dovish environment. The report says it "looks cheap".

Citigroup believes that this pricing deviation implies that the market underestimates the possibility of both rising simultaneously. Therefore, the bank is optimistic about the strategy of pairing the upside risk of stocks with that of gold.

Market pricing indicates that the Federal Reserve is clearly dovish

In the report, Citigroup constructed an indicator of the Federal Reserve's policy stance, which assesses the Fed's policy inclination by analyzing the residuals between market terminal interest rate pricing and market-based inflation and growth indicators.

The report indicates that the indicator is currently at a low level, suggesting that the Fed's pricing is "overly loose" relative to the fundamentals.

The report further explains that this dovish stance is based on considerations of future risks to the US economy, especially signs of weakness in the labor market and possible personnel adjustments within the FOMC. Data shows that the unemployment rate in the United States is continuously rising and the duration of unemployment is also increasing. All these constitute reasons that prompt the Federal Reserve to maintain its loose policy.

No longer a traditional safe-haven asset, the potential of gold is still underestimated

In this policy-driven "fiscal domination" environment, the correlations among assets will undergo a systematic transformation. Citigroup pointed out that the correlation between gold and risky assets (such as the S&P 500 index and the Nikkei Index) as well as risky currencies (such as the Australian dollar and the British pound) often becomes more positive than the implicit pricing in the market.

It is worth noting that the market has not fully digested this shift in correlation. By comparing the six-month implied correlation between gold prices and risky assets (derived from options market pricing) with the realized correlations during the same period in history, Citigroup found a significant deviation between the two.

Citigroup emphasized that gold is often wrongly regarded as a safe-haven asset, and in fact, the relationship between gold and bond yields is structurally unstable, which weakens its justification as a pure safe-haven tool.

Therefore, Citigroup tends to view gold as a tool to hedge against "higher term premiums or policy failures".

Against the backdrop of the current Federal Reserve adopting a loose stance to address potential economic risks, this attribute of gold makes it stand out. This explains why, in an environment where risk appetite is on the rise, gold can still strengthen in tandem with assets such as stocks.

Based on this logic, the report holds that the combination of "rising gold + rising stocks" is reasonable.

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