Nomura expects the Fed to remain on hold, but inflation credibility pressures are raising the risk of rate hikes

Overview

This is Nomura's U.S. economic weekly report, focusing on the July FOMC, U.S. employment, core PCE, wage data, and economic activity. The report believes that the Fed's decision to leave rates unchanged was in line with expectations, but that Chair Warsh's dovish stance and failure to clearly explain the policy reaction function have weakened market confidence in the Fed's anti-inflation credibility. Meanwhile, U.S. growth and the labor market remain resilient. Although inflation may gradually slow, policy risks have shifted toward rate hikes.

Core views

Nomura expects the Fed to keep rates unchanged for an extended period, but the Committee may be forced to tighten policy if inflation reaccelerates or inflation expectations become unanchored. The report expects July nonfarm payrolls to rebound from 57k in June to 130k, the unemployment rate to remain at 4.2%, and average hourly earnings growth to decline to 0.2% month over month. June core PCE was significantly below expectations, supporting the Fed's wait-and-see stance, but market reactions to long-term inflation expectations have made policy communication the main source of risk.

Analysis framework

The report combines macroeconomic data tracking with analysis of the policy reaction function to assess changes in FOMC statements, the Chair's press conference language, inflation and wage data, leading employment indicators, U.S. GDP components, and market-implied inflation expectations.

Methodology notes

• Monetary policy analysisFederal Reserve reaction function

  Assess the FOMC's future interest-rate path through inflation, employment, financial conditions, and policy communication.

  The report emphasizes that Warsh did not clearly specify what inflation conditions would trigger a rate hike, while suggesting that rising market yields could substitute for some policy tightening, increasing policy uncertainty.

• Macroeconomic data analysisTracking leading employment and inflation indicators

  Use nonfarm payrolls, the unemployment rate, average hourly earnings, initial and continuing jobless claims, services surveys, core PCE, and ECI to assess economic momentum.

  The report believes that services surveys, continuing jobless claims, and weekly ADP data point to improved employment in July, while cooling wages and core PCE support a gradual easing of inflation over the coming months.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• U.S. Treasuries

  Long-term yields are highly sensitive to inflation credibility and policy uncertainty.

  Strengths

  If core PCE continues to slow, upward pressure on yields may ease.

  Weaknesses

  Rising long-term inflation expectations and rate-hike risks could push up 30-year yields.

  Comparison

  Compared with short-term rates, long-term yields more directly reflect changes in inflation expectations and term premiums.

  Risks

  Reaccelerating inflation, unanchored inflation expectations, and Fed communication mistakes.

• 5y5y forward breakeven inflation

  The report views it as a key signal of changes in market perceptions of the Fed's inflation credibility.

  Strengths

  If core PCE cools in the future, it could help stabilize long-term inflation expectations.

  Weaknesses

  The indicator jumped after the July FOMC meeting, showing market concern that the Fed is too dovish.

  Comparison

  Compared with spot inflation data, this indicator better reflects whether long-term inflation expectations are anchored.

  Risks

  A sustained rise could force the FOMC to take more hawkish action.

• U.S. risk assets

  Resilient U.S. growth and AI-related capital expenditure support fundamentals, but higher rates and the risk of an AI bubble bursting create pressure.

  Strengths

  Consumption, equipment investment, and intellectual property investment remain strong, with signs of broader capital expenditure growth.

  Weaknesses

  Valuations may be constrained by rising long-term yields and tighter financial conditions.

  Comparison

  Compared with interest-rate assets, risk assets are additionally exposed to the AI investment cycle and changes in earnings expectations.

  Risks

  A slowdown in AI investment, escalating geopolitical conflicts, and political pressure undermining the Fed's credibility.

Key data

• July nonfarm payrolls forecast130kAbove June's 57k and the year-to-date average of approximately 92k.
• July unemployment rate forecast4.2%Expected to remain unchanged from the previous month, with layoff indicators still at low levels.
• July average hourly earnings forecast0.2% m-o-mBelow June's 0.3% m-o-m, consistent with slowing alternative wage indicators.
• June core PCE0.132% m-o-m; 3.287% y-o-yBelow consensus expectations of 0.2% m-o-m; Nomura believes year-over-year core PCE peaked in May.
• Q2 ECI0.9% q-o-qAbove Nomura's 0.7% forecast and the 0.8% consensus, with strength mainly coming from goods-producing industries.
• Q2 real GDP1.5% q-o-q annualizedBelow Nomura's 1.8% forecast and the 2.0% consensus, but private domestic final demand accelerated to 3.9%.
• Q4 2026 core PCE forecast3.2% y-o-yBEA methodological adjustments could lower this by approximately 20bp to 3.1%.

Impact & implications

For markets, the report's core implication is that mild near-term inflation data support the Fed's wait-and-see stance, but unclear policy communication and rising long-term inflation expectations could continue to pressure long-term U.S. Treasury yields. If subsequent inflation data reaccelerate, markets may price in rate-hike risks more quickly. The resilience of the U.S. economy also means there is insufficient justification for rate cuts, while risk assets remain exposed to shocks from the AI investment cycle, geopolitical conflicts, and tighter financial conditions.

Risks

• Inflation or core PCE reaccelerates, triggering greater market concern about the Fed's credibility.
• Long-term inflation expectations become unanchored, forcing the FOMC to shift toward tighter policy.
• Increasing political pressure could weaken the Fed's independence and trigger a sharp market reaction.
• An escalation of the Iran war or other geopolitical risks could push up energy prices and tighten financial conditions.
• An AI bubble burst could lead to asset valuation corrections and weaker corporate investment.
• Memory chip shortages and supply-chain disruptions could create second-round inflationary pressure.

What to watch

• Whether July nonfarm payrolls, the unemployment rate, and average hourly earnings are in line with Nomura's forecasts.
• Whether core PCE gradually slows over the coming months as expected.
• Whether 5y5y forward breakeven inflation and 30-year U.S. Treasury yields continue to rise.
• Whether Warsh further explains the policy framework in his Jackson Hole speech.
• Whether ISM manufacturing, ISM services, JOLTS job openings, and initial jobless claims confirm labor-market resilience.
• The impact of BEA methodological adjustments to PCE price components on the core PCE path.