"Wash debut" is a "once-in-a-decade turning point"? Nomura: Beware of "precautionary rate hikes" evolving into "substantive tightening"

Nomura Securities Chief Macro strategist Naka Matsuzawa believes that the June Federal Reserve meeting could be seen in hindsight as a "turning point once in a decade" - the inflection point of the credit cycle and the beginning of the end of AI prosperity. According to a report released by Matsuzawa, the market currently overestimates the risk of Fed rate hikes this year, but severely underestimates the risk of the longer-term rate hike path. He warned that the current market and Fed's characterization of one or two rate hikes as "preventative" carries substantial risks of evolving into a systemic tightening cycle. If this happens, it will have profound impacts on the credit cycle. The core basis for this judgment is Matsuzawa's expectation that AI-related investments and AI-driven productivity improvements will drive economic growth and inflation beyond the Fed's expectations. If this scenario plays out, the 10-year Treasury yield may exceed 5%. The market has not fully digested the signals from the FOMC meeting Matsuzawa pointed out that the market has not fully absorbed the information from the recent FOMC meeting, which to some extent is not surprising. Because the key member of the FOMC, the new Chairman Powell, has spoken very little so far and has not submitted his own interest rate forecast in the dot plot. He is particularly concerned about two points: First, the urgency and triggers for Fed rate hikes; Second, the actual possibility of the Fed initiating rate hikes. He believes that the market overestimates the former and underestimates the latter, which is more worrisome. Matsuzawa expects that speeches from Fed officials taking a neutral to dovish stance in the coming week, including Christopher Waller and John Williams, will help alleviate concerns about the urgency of rate hikes this year. However, there will be no new substantial information on the depth and persistence of the rate hike path in the near term, with the next important data release being the US employment data on July 2. Dot plot logic is self-contradictory, can the "insurance rate hike" framework stand? The median forecast on the dot plot from the recent FOMC meeting shows one rate hike in 2026, and rate cuts in 2027 and 2028. This path logically raises a direct question: if the Fed plans to cut rates in the future, why raise rates now? Matsuzawa interprets that members advocating for rate hikes this year (mainly likely regional Fed presidents) characterize the current rate hike as purely an "insurance operation". The logic is that one preventive rate hike is enough to prevent the economy and inflation from overheating, with factors such as stable oil prices ultimately creating space for rate cuts back to the neutral rate of 3.1%. The mild framework is supported by the economic forecasts from the recent meeting: Economic growth forecasts for 2026 to 2028 are 2.2%, 2.3%, and 2.2%, with little change; Unemployment rate forecasts are 4.3%, 4.3%, and 4.2%, barely reaching full employment level (4.2%) until 2028. The lower limit of the 2028 unemployment rate forecast range is 4.0%, indicating that hardly any members are concerned about risks of the economy and inflation overheating. Matsuzawa believes the Fed will stay put in 2026. He thinks that once Powell's policy stance becomes clear, or if inflation expectations stabilize (such as oil prices further falling), the current market expectation of around 1.5 rate hikes this year may quickly be revised or even disappear. The biggest risk: preventive rate hikes sliding into substantial tightening cycle However, Matsuzawa holds a drastically different view on the longer-term path. He is skeptical of the consensus assumption that "the economy and inflation will not overheat before 2026." The report points out that the continued expansion of AI-related investments and the boost to productivity from AI (i.e., increasing actual income) will accelerate economic growth and inflation beyond the Fed's expectations. If this scenario occurs, the Fed will not stop at one or two preventive rate hikes, but will have to enter a regular tightening cycle to suppress overheating of the economy and inflation, or the market will factor in this path ahead of time. Historical data provides a reference: in the recent rate hike cycle from 2022 to 2023, the 2-year real yield reflecting policy rate expectations once exceeded 3.0% until shocks triggered financial turbulence and economic slowdown, leading to a drop. (The inflation expectations and real yields at different terms in the US) Currently, the 2-year real yield is around 2.00%, indicating that the Fed still has at least 100 basis points of rate hike space. Matsuzawa warns that if this scenario truly unfolds, the 10-year Treasury yield will likely significantly exceed 5%. The significance of the credit cycle as a "once in a decade turning point" Naka Matsuzawa proposes a more macrostructural proposition in the report: looking back through history, this FOMC meeting may be proven to be a "game changer once in a decade" - the starting point of the end of the credit cycle and AI prosperity. His core logic is that AI prosperity will not naturally end, and it can only be ended when the Fed truly starts to raise rates. From the perspective of the credit cycle, the end of AI prosperity also means that the bond market will "discover the true neutral interest rate" and break free from the structural downtrend. While the market has priced in rate hikes earlier than Matsuzawa's previous expectations, the form of the rate hike path (first up, then down, ultimately returning to the original point) indicates that the market still views this rate hike cycle as a one-time preventive operation. If this judgment is wrong, the entire evolution logic of the credit cycle will be completely rewritten. This article is reprinted from "Wall Street News", GMTEight editor: Jiang Yuanhua.