USD/JPY held a narrow range in the Asian session on Friday, trading just under 162.00 near a four-decade high, and remained set for a second straight weekly gain. The pair was little changed after Tokyo inflation data, with the Statistics Bureau of Japan reporting Tokyo headline CPI rising to 1.7% year on year in June from 1.4% previously. Core CPI, excluding fresh food, increased to 1.6% from 1.3%, while the measure excluding both fresh food and energy edged up to 1.9% from 1.6%.
The yen struggled to find sustained support, with the Japan–US rate gap keeping carry activity in focus, while tensions in the Middle East added another pressure point. Reports that Iran’s Islamic Revolutionary Guard Corps attacked a Singapore-flagged cargo ship in the Strait of Hormuz lifted demand for the US dollar, although expectations for US Federal Reserve rate hikes this year have eased. Speculation that Japanese authorities could intervene to support the currency limited follow-through, leaving USD/JPY capped but biased upward.
Interest Rate Differentials and Carry Trade Dynamics
Given the upward momentum in USD/JPY, we believe any pullback should be treated as a buying opportunity in the coming weeks. The primary driver remains the significant interest rate difference between the US and Japan, which encourages borrowing in yen to invest in higher-yielding dollars. This fundamental picture suggests the path of least resistance is for the pair to climb higher.
We believe the interest rate gap will continue to drive this trade, as the current Federal Funds Rate stands near 4.75% while the BoJ’s policy rate is only at 0.50%. This substantial 425 basis point differential continues to fuel the carry trade, making it costly to bet against the dollar. Historical data shows that as long as this wide gap persists, the yen is likely to remain under pressure.
Risks of Intervention and Geopolitical Considerations
However, with the pair near a 40-year high around 162.00, the risk of sudden and sharp intervention from Japanese authorities is extremely elevated, similar to the moves seen in 2024. To manage this risk, we are favoring buying USD/JPY call options, which allows us to profit from further upside while limiting our maximum loss to the premium paid. This approach protects us from a sudden, intervention-driven collapse in the pair’s price.
The geopolitical tensions in the Strait of Hormuz are also adding to safe-haven demand for the US dollar, providing another pillar of support for the currency pair. This risk, combined with the intervention threat, is keeping implied volatility in the options market high. While this makes buying calls more expensive, we view it as a necessary cost to safely navigate these market conditions.
