USD/JPY started the week firmer, moving back above the mid-161.00s in Asia and staying close to last Thursday’s peak, its highest level since July 2024. Japanese officials reiterated they are ready to respond to currency moves at any time, yet the yen continued to lag as markets weighed the Middle East conflict and energy supply disruptions through the Straight of Hormuz. Iran said it had closed the waterway again after accusing the US and Israel of violating the ceasefire, and linked the move to continued Israeli strikes in Lebanon. Donald Trump warned of fresh military action against Iran if Hezbollah attacks on Israel persisted, keeping geopolitical risk premia elevated.
That backdrop has tempered expectations for further Bank of Japan tightening to support the yen, even as April minutes showed some members favoured faster rate increases to prevent underlying inflation from overshooting. Deputy Governor Himino said the BoJ would keep hiking based on economic, price and financial trends. Japan’s policy rate stands at 1.00%, its highest since 1995, while the Federal Reserve held its target range at 3.5% to 3.75%, reinforcing the JPY carry trade. Traders also priced in at least one 25-bps Fed hike in 2026, helping the dollar steady after Friday’s pullback from a May 2025 high.
Interest Rate Differentials And The Carry Trade
Given the widening interest rate differential between the US and Japan, we see continued upward pressure on the USD/JPY. The carry trade remains highly attractive, as borrowing in yen to invest in higher-yielding US assets is a compelling strategy. This fundamental driver is unlikely to change in the coming weeks, suggesting the path of least resistance for the pair is higher.
With the pair trading above 161.00, the risk of direct intervention from Japanese authorities is extremely high. We should therefore use options to structure our trades, primarily by buying USD/JPY call options to capitalize on further upside while strictly limiting our maximum loss. This approach allows us to participate in the rally without exposing ourselves to a sudden, sharp reversal caused by official action.
Intervention Risks, Volatility, And Economic Fundamentals
Historically, Japanese authorities have acted decisively around these levels, such as when they spent a record ¥9.2 trillion in the spring of 2024 to defend the currency. Given this precedent, we believe using bull call spreads is also a prudent strategy. This would involve buying a call and selling a higher-strike call, which lowers the cost of the trade and profits from a continued, steady climb.
We must also be aware that implied volatility is elevated due to both intervention risks and the geopolitical tensions in the Middle East. This makes options more expensive, but we see this as the necessary cost of insurance against sudden, high-impact events. The instability surrounding the Strait of Hormuz, a critical channel for Japan’s energy imports, will likely keep volatility high and support the safe-haven dollar.
The underlying weakness in the Japanese economy further supports our view. As a nation that imports over 90% of its energy, Japan is exceptionally vulnerable to supply disruptions and rising oil prices stemming from the Middle East conflict. This economic strain will continue to weigh on the yen, overriding the Bank of Japan’s hawkish rhetoric for now.
