Nomura points to growing evidence that the short-term "neutral rate" has risen in response to a number of factors, including 1) looser than expected financial conditions, 2) a resilient labor market; 3) still-high inflation, which suggests that the nominal "neutral rate" may be higher than 2-2.5%.

The "neutral interest rate" refers to the level of interest rate that neither stimulates nor inhibits economic growth, and is a theoretical interest rate that guides monetary policy. A higher "neutral rate" means that Fed policy at any given level will be more accommodative than previously thought.

As a result, Nomura is now raising its peak forecast for the Fed's rate hike cycle by 75 basis points to 5.25-5.50%. According to its roadmap, the Fed will raise rates by 75 basis points at each of its remaining two meetings this year, followed by a 50 basis point increase in February and another 25 basis point increase in March.

Nomura also maintained their growth outlook, which was below consensus. It expects the US economy to start slipping into recession in the fourth quarter of this year, with unemployment peaking at around 6% in 2024. However, Nomura also said that because the "neutral rate" is higher than previously thought, the likelihood of a recession being delayed until the first quarter of 2023 has become greater.

In terms of rate cuts, Nomura expects the Fed to cut rates at an initial pace of 25 basis points per meeting starting in September next year, and to accelerate to 50 basis points per meeting by the second quarter of 2024, bringing the policy rate all the way down to 1.125 percent by the end of 2024.

Market situation

As for the situation in financial markets, Nomura said that both US real interest rates and the dollar have been pushed to multi-year highs, which is a pure "tightening of financial conditions" impulse and a poison for risk assets.

After non-U.S. currencies tumbled against the dollar over the past month, Charlie McElligott, strategist at Nomura, quipped that everything else is like emerging markets right now.

With the macro situation continuing to be unstable, Nomura strategists noted that "we are seeing options indicators such as Vol/Skew/Put Skew/Crash in U.S. equities finally starting to 'bid' after more than six months of low water, as the probability of left-tail risk has increased."

Left-tail risk refers to the risk that has a very small probability of occurrence, but will cause extremely serious losses if it occurs.

Right now, the VVIX, a measure of US stock volatility, is on track for its second biggest one-day rise since November 2021.

This makes Nomura's CTA trend model "100% short" in all major U.S. stocks...