Beisen Te wants "U.S. interest rate cuts, Japan interest rate hikes," Nomura: Possible, but with conditions

The U.S. Treasury Secretary has called for the Federal Reserve and the Bank of Japan to adopt aggressive and completely opposite monetary policy paths, a rare statement that has caused turbulence in global markets. Nomura analysis believes that this policy divergence is not entirely impossible, but its realization faces a series of harsh preconditions and potential risks, while also exposing possible inherent contradictions in the current market narrative.

Recently, U.S. Treasury Secretary Janet Yellen sent an unusually clear and aggressive policy signal to the market. She not only advocated for the Federal Reserve to start cutting interest rates by 50 basis points from September and subsequently reduce them by a cumulative 150 to 175 basis points, but also suggested that the Bank of Japan should raise interest rates. Yellen emphasized that rapid rate cuts are crucial to alleviating the pressure that high real interest rates in the U.S. place on credit, real estate, and small and medium-sized banks, while Japan needs to raise rates to address inflation and stabilize the yen.

The strength of this proposal far exceeds current market expectations. The Federal Reserve's target interest rate range is currently 4.25%-4.5%, and a 150 basis point cut would mean the midpoint would drop to 2.88%, while the market pricing suggests that it may not reach 3% until next fall. Yellen's statement essentially outlines a monetary policy divergence for the two major global economies, depicting a scenario of "U.S. rate cuts and Japanese rate hikes," which will profoundly reshape the global interest rate structure, capital flows, and asset prices.

The market's reaction has been complex and divided. The Japanese stock market unexpectedly surged, while the yen strengthened under the dual influence of U.S. rate cut expectations and Japanese rate hike expectations.

In response, according to reports from the trading desk, different teams within Nomura Securities have interpreted the situation from their respective perspectives. Its global foreign exchange strategy team believes that the coexistence of Federal Reserve rate cuts and Bank of Japan rate hikes is "feasible," but whether this scenario can be realized depends on several key preconditions, including the pace of Federal Reserve rate cuts and the economic performance and political stability in Japan.

However, Nomura's macro strategy team warned that this seemingly contradictory policy combination hides a fundamental divergence in the market's outlook on the global economy, with a combination of U.S. policy rates ending above 3.0% and Japan's below 1.0% being "unnatural." There is an inherent contradiction in the market's pricing of the future paths of the two central banks, and ultimately one side will have to be corrected. Regardless of which divergence is disproven, it could trigger market adjustments.

Key Preconditions for Feasibility: Federal Reserve Rate Cut Magnitude and Stability of Japan's Economy and Political Situation

Nomura Securities' global foreign exchange strategy team believes that the core foundation for the coexistence of "U.S. rate cuts and Japanese rate hikes" lies in the stability of Japan's economic fundamentals. Data shows that Japan's economy has shown some resilience to U.S. tariff measures so far.

According to data cited in the report, Japan's GDP annualized growth rate for the second quarter was 1.0%, far exceeding the market's general expectation of 0.4%, while the first quarter GDP was also revised from -0.2% to +0.6%, significantly alleviating concerns about an economic recession. Detailed data shows that household consumption, private capital expenditure, and exports have all performed robustly. Additionally, the economic outlook survey in July indicated that the future economic index has risen to its highest point since January. Nomura believes that although the full impact of tariffs still requires time for assessment, there have not been any significant negative signals so far The report points out that if the Japanese economy and price outlook develop as expected, it would be "reasonable" for the Bank of Japan to advance interest rate hikes and normalize monetary policy.

Another key premise of the "coexistence" scenario depends on the pace of actions by the Federal Reserve. Nomura analysis states that if the Federal Reserve initiates a round of "preventive" moderate interest rate cuts, such as a 25 basis point cut starting in September, the Bank of Japan would still have room to tighten its policy.

However, the Nomura foreign exchange strategy team warns that if weak U.S. economic data prompts the market to raise expectations for a 50 basis point rate cut in September, the Bank of Japan's tightening path will become "challenging." In other words, aggressive rate cuts by the Federal Reserve may compress the operational space for the Bank of Japan.

In addition to the pace of U.S. policy, domestic political uncertainty in Japan is a major downside risk facing this scenario. The Nomura foreign exchange strategy team indicated in the report that Prime Minister Shigeru Ishiba may resign in the coming weeks, which could temporarily weigh on expectations for tightening by the Bank of Japan.

The report analyzes that if Ishiba resigns and triggers an internal party leadership election, the emergence of a new prime minister inclined towards more accommodative fiscal and monetary policies could lead to a decline in market expectations for interest rate hikes by the Bank of Japan.

However, the Nomura foreign exchange strategy team also pointed out that given Japan's economic growth is stronger than expected and shows resilience to tariffs, the necessity and rationale for implementing large-scale easing measures (such as cutting consumption tax) seem to have diminished. Therefore, even if there are political changes, as long as economic indicators remain robust, the likelihood of a significant policy shift will decrease.

Nomura Macro Strategist: One Side of the U.S.-Japan Interest Rate Endpoint Must Be "Corrected"

From a more macro perspective, another strategist at Nomura, Naka Matsuzawa, believes that the combination of a U.S. policy interest rate endpoint above 3.0% and a Japanese rate below 1.0% is "unnatural," and there is an inherent contradiction in the market's pricing of the future paths of the two central banks, which will ultimately lead to a correction on one side.

Matsuzawa elaborated on two possibilities in his weekly report:

The first scenario is that "the Federal Reserve is behind the curve." If the U.S. economy is indeed rapidly losing momentum, then Bessenet's view is correct, and the Federal Reserve needs to immediately cut rates significantly below 3.0%. In this scenario, the U.S. dollar and global stock markets will weaken, risk aversion will increase, and the impact on the Japanese stock market will be more severe, as shrinking global demand and yen appreciation will double squeeze corporate profits.

The second scenario is that "the Bank of Japan is behind the curve." If the global economy remains robust, then the issue lies with the Bank of Japan. This means the Bank of Japan needs to raise interest rates more quickly to catch up with inflation. In this scenario, global yields will rise, the yen may be pressured due to interest rate differentials, but solid economic fundamentals will support the stock market, especially interest rate-sensitive sectors like banks.

Matsuzawa assesses that the recent strong rebound in the Japanese stock market is partly due to market participants possibly being overly optimistic about the global economy, overestimating the probability of Federal Reserve rate cuts while underestimating the likelihood of Bank of Japan rate hikes. **He believes that if the mispricing of the first scenario (global economic slowdown) is corrected, the negative impact on the Japanese stock market will far exceed that of the second scenario **

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