Former European Central Bank President Jean-Claude Trichet said on Tuesday that the recent rapid strengthening of the yen can be seen as an overdue healthy correction and now is not the time to panic about broader market turmoil.
Trichet told CNBC’s “Squawk Box Europe” that a hawkish turn in Japanese monetary policy, geopolitical tensions in the Middle East and disappointing U.S. jobs data rocked global markets on Friday and Monday.
“In my opinion, these three factors have come into play and triggered a correction in dollar-yen that was long overdue because everyone knew that the yen was at an irrational level and the carry trade had been very active for a long time,” Trichet said.
A "correction" is generally defined as a drop of 10% or more in the value of an asset or index, bringing it closer to its long-term trend. The "carry trade" involves investors borrowing in a low-interest currency and reinvesting it in higher-yielding assets elsewhere, using the difference to profit. In recent years, investors have flocked to the yen carry trade, attracted by Japan's low volatility and ultra-easy monetary policy.
The yen's rapid appreciation began last Wednesday, when the Bank of Japan raised its benchmark interest rate and laid out plans to scale back its bond-buying program.
The dollar plunged nearly 5% against the yen last week and fell further on Monday, although it rebounded on Tuesday. At the same time, global stock markets plunged, supporting "safe haven" assets such as the Swiss franc and U.S. Treasuries.
“It is impossible not to inflict pain as the world’s largest carry trade ever unwinds,” Kit Juckes, chief currency strategist at Societe Generale, said in a statement on Monday.
“In some ways this correction can be seen as a healthy correction,” Trichet told CNBC on Tuesday. “Of course, we have to be extremely cautious, but in terms of the corrections we observed last Friday and Monday, we have good reasons to explain it.”
“A correction is probably long overdue,” he said. “There are some positives in the U.S., Europe and the global economy that are still there, so there’s no reason to panic. It’s very, very important not to panic at this critical juncture in my opinion.”
"I don't think there is reason to panic about the outlook for the U.S. economy," Trichet added, noting that the U.S. composite purchasing managers' index (PMI) remained in growth territory in July.
Talk of a U.S. recession broke out after a weaker-than-expected July jobs report, but some economists and Federal Reserve policymakers argued the data did not show signs of a severe recession.
Markets are already confident the Fed will cut rates at its next meeting in mid-September and have increased bets on a 50 basis point cut, giving it almost a 75% chance of happening, according to CME Group’s FedWatch tool. Some are also speculating the Fed may need to implement an emergency rate cut.
However, Trichet said on Tuesday that while the Fed may "hesitate" between 25 and 50 basis points, current data does not support an emergency rate cut.
“Given everything we know, I think it’s unlikely that the Fed would create a sense of anxiety that is not entirely justified,” he said, adding that more data in the coming weeks would present a clearer picture of the economy.
On inflation, Trichet said that although inflation in the United States and the eurozone is still above target, the anti-inflation trend that has been going on for some time should be attributed to central banks.
He concluded: “To the extent that some of the things that happened in the market were unforeseen, it could be interpreted as a healthy correction, but I remain very cautious and careful.”
The article is forwarded from: Jinshi Data
