Unprecedented differences, inevitable turbulence! This central bank annual meeting may only reach one consensus

This week, central bank governors from various countries will gather for one of the world's most famous annual economic forums. They will find that the divergences between them may be greater than at any time before the outbreak of the pandemic.

For years, the evaluations of the Federal Reserve, the European Central Bank, and many counterparts in developed countries have been roughly similar. At the beginning of the 2020 COVID crisis, they lowered interest rates and injected liquidity. However, when inflation did not disappear on its own, they implemented the most aggressive tightening policies in decades to address inflation.

Even over a year ago, monetary policy officials at the European Central Bank's annual meeting in Sintra, Portugal, held the same view - they believed there was more work to be done in curbing inflation. Bank of England Governor Bailey stated at the time, "We face common shocks that affect all of us."

Now, as inflation falls but remains above the 2% target, officials are facing widening divergences as they weigh the risks of excessive price pressures and the danger of the economy slipping into recession. For investors, this will be a more turbulent backdrop.

Over two months ago, the European Central Bank already cut its benchmark interest rate, but the Federal Reserve has not yet pulled the trigger. The Bank of England took action on August 1st, but its policy-setting committee only narrowly passed the rate cut decision with a 5-4 majority. The Reserve Bank of Australia Governor cited criticisms from both sides of the rate debate this month, with some advocating for rate hikes and others calling for rate cuts.

After maintaining the interest rate on August 6th, RBA Governor Lowe said in a press conference, "I wish I had their certainty. The problem is, while we have a lot of data to tell us what happened in the past, economic models cannot fully capture what has happened in the economy."

Federal Reserve Chairman Powell is set to speak at the Jackson Hole Symposium hosted by the Kansas City Fed on Friday, where he stated last month, "Forecasters are continually surprised."

The theme of this year's conference is "Reassessing" the effectiveness of monetary policy and how it transmits to the broader economy. Top representatives from major central banks usually attend this conference, which also helps shape investor expectations.

Various signs of the U.S. economy are mixed - the July jobs report was much weaker than economists predicted, but retail sales for the same month exceeded expectations, making it more challenging to judge when and by how much to ease. This is also reflected in the futures market ahead of the Jackson Hole conference.

The volatility of one-year Federal Funds futures is the highest this year. Last week, the 30-day realized volatility of the contract surged to 1.86, the highest since June 2023 when the volatility increased due to the U.S. regional banking crisis. The current reading is nearly three times the average since 1991.

The July jobs report showed an unexpectedly sharp rise in the unemployment rate, coupled with a stock market decline, leading traders to bet that the Fed will cut rates by 50 basis points at the September meeting, or even cut rates earlier. Now, futures trading indicates that the Fed is more likely to take a smaller 25 basis point rate cut Last week, New Zealand witnessed an extreme example, illustrating the uncertainty faced by central bank governors in this stage of the economic cycle. The unexpected rate cut by the Reserve Bank of New Zealand left observers stunned, especially since the central bank had signaled three months ago that it would not take any rate-cutting measures until next year.

The sudden shift by the Reserve Bank of New Zealand "has raised significant doubts about the bank's interpretation and forecasting of the economy - frankly, it's hard to believe its judgment," said Brad Olsen, an economist at the policy think tank Infometrics in Wellington, New Zealand. "The wavering views also mean that no one can be certain about what will happen next."

Officials at the Reserve Bank of New Zealand defended their actions, stating that they reacted based on the information available at the time. Reserve Bank of New Zealand Governor Orr later mentioned that future actions may be "cautious" and "measured."

Unexpected Moves

The move by the Reserve Bank of New Zealand came a week after the Governor of the Bank of Japan had to swiftly readjust its messaging.

On July 31, the Bank of Japan unexpectedly raised its key interest rate by 15 basis points and included forward guidance in its policy statement, indicating further rate hikes in the future. By August 7, following stock market turmoil and a surge in the Japanese yen, the Bank of Japan sent a strong dovish signal, pledging not to raise rates during market instability.

In Europe, central bank officials are facing a dilemma, as recent inflation data showed that the Eurozone inflation rate unexpectedly rose to 2.6%, while there are signs of economic performance falling below expectations. Officials expect the inflation rate to reach the 2% target by the end of 2025, but they consistently emphasize the high level of uncertainty.

Some policymakers, like Yannis Stournaras of Greece, believe that further evidence of weak economic growth justifies the need for more accommodative policies, while others stress that inflation remains a tricky issue. Governing Council member Isabel Schnabel stated at the end of July, "We need to remain vigilant."

The market anticipates two more rate cuts by the European Central Bank this year, with the likelihood of a third rate cut exceeding 50%.

Widespread Uncertainty

This month, there was a split vote in the Monetary Policy Committee of the Bank of England, with Bailey differing from his Chief Economist Huw Pill, who voted against a rate cut. Bailey mentioned after the August meeting that rate setters are uncertain about which of the various scenarios for the economy might unfold and have differing views on their likelihood.

These scenarios include a "presumed" scenario of price pressures being released and a less optimistic outcome where permanent changes in price and wage setting require longer periods of tightening policy. Bailey stated that due to "high levels of uncertainty," the report presented multiple alternative scenarios In conclusion, uncertainty may be something that all central bank governors can agree on