Global central banks collectively shifting, should financial markets be cautious instead?

As the focus of officials from the Federal Reserve and the European Central Bank shifts from high inflation to a weak job market, the Bank of Japan reiterated its determination to steer the Japanese economy away from decades of loose monetary policy as signs of continuous price growth become more apparent. With major central bank policies diverging, signs of sluggish economic growth and risks in the job market are casting a shadow over the policy outlook of European and American central banks, highlighting potential turbulent prospects for the market.

Policy divergences, coupled with the sustained weakness of the global economy, indicate that the global economy and financial markets are in a period of turmoil. Decision-makers at the global central bank annual meeting have already sensed what could happen, as earlier this month, weak U.S. non-farm payroll data raised concerns about an economic recession and exacerbated the market plunge triggered by the Bank of Japan's unexpected rate hike in July.

So far, many analysts agree with the International Monetary Fund (IMF)'s forecast that global economic growth will be moderate in the coming years as the U.S. achieves a soft landing and European economic growth picks up. However, this optimistic forecast is built on shaky ground as doubts arise in the market about the prospect of a U.S. soft landing and the failure of Eurozone economic growth to recover.

While major central banks are shifting towards rate cuts, it is still premature to determine whether these measures can be classified as the "normalization" of restrictive policies or as initial steps to prevent further economic slowdown.

This uncertainty may make global stock markets and currencies vulnerable to volatility.

IMF Chief Economist Pierre-Olivier Gourinchas stated that as major central banks enter a period of monetary easing after tightening policies to combat inflation, "we may see another chapter of market volatility as the market is in uncharted territory. Japan is in a slightly different cycle. The market needs to figure out what all this means, and the market reacts sharply. Therefore, we will face further volatility."

Risks to Economic Growth

Federal Reserve Chairman Powell delivered a highly anticipated speech last Friday, implicitly supporting an immediate start to rate cuts and indicating a reluctance to wait for further cooling of the job market. This marks a significant shift compared to Powell's comments during the surge in inflation in 2021 and 2022, reinforcing the view that the Federal Reserve is undergoing a policy shift. A new study published at the Jackson Hole symposium suggests that the U.S. economy may be nearing a critical point where the continued decrease in job vacancies will translate into faster growth in the unemployment rate.

Policy makers at the European Central Bank are reaching a consensus on rate cuts in September, partly due to easing price pressures but also because of significantly weakened growth prospects. The Eurozone economy saw almost no growth last quarter, with its largest economy Germany contracting, manufacturing still in deep recession, and heavily impacted by weak external demand, resulting in sluggish exports.

ECB Governing Council member Olli Rehn stated: "Recent increased risks of negative growth in the Eurozone have strengthened the case for the ECB to cut rates at the next monetary policy meeting in September." Even in Japan, recent inflation data shows that demand-driven price growth is slowing, which may complicate the decision for the Bank of Japan to further raise interest rates. Analysts say that despite a rebound in Japanese consumption in the second quarter, there is still uncertainty as to whether wage increases are sufficient to offset the impact of rising household living costs.

Sayuri Shirai, former board member of the Bank of Japan and current economics professor at Keio University in Tokyo, said: "Domestic demand in Japan is very weak. From an economic perspective, the Bank of Japan has almost no reason to raise interest rates."

Further signs of a slowdown in US economic growth will be a bad omen for global manufacturers who are already feeling pressure due to tepid demand. Private surveys show that factory activity in the US, Europe, and Asia was struggling in July, increasing the risk of insufficient global economic recovery momentum.

For resource-rich emerging economies like Brazil, a global economic slowdown could hit metal and food exports, but cheaper imports could help alleviate inflationary pressures