The recent US-China trade agreement has led to optimism, affecting currency performances. The JPY has declined nearly 1.6% against the USD, becoming the weakest G10 currency over one session. There is an expectation of USD strength due to short covering, though the forecast for USD/JPY remains at 140.00 over 12 months.

The USD has struggled as the worst performing G10 currency so far this year. Although there was a bounce seen in the USD due to trade deal optimism, the build-up of long USD positions has contributed to its weak trend. Concerns over a potential US recession linked to tariff policies have further impacted the USD negatively.

Japan’s Trade Position

Japan holds a relatively strong position in trade talks with the US, being a major FDI provider and defence partner. However, the upcoming Upper House elections in Japan might add complexity to negotiations. The JPY’s recent gains suggest no immediate rush for BoJ rate hikes, but a potential rapid JPY unwind could influence rate hike expectations. This quarter’s short covering might support the USD, but a trade compromise between the US and Japan could lead to a USD/JPY downtrend in the later half of the year. The USD/JPY forecast is maintained at 140.00 for 12 months.

With short covering providing a temporary lift to the US dollar, market sentiment has shifted in the near term. However, the broader trajectory remains weighed down by persistent headwinds. The weak performance by the dollar over the year so far isn’t simply the result of positioning; deeper structural concerns are at play, particularly those tied to the long shadow cast by trade policy uncertainty and recessionary fears. When long positions unwind and sentiment turns, the move can be sharp, and we’ve now seen early signs of that rebalancing dynamic emerging.

Dollar-yen, in particular, has exhibited volatile behaviour in light of both political developments and market repricing. The recent softness in the yen was accelerated by geopolitical easing, but that shouldn’t suggest a durable trend favouring dollar appreciation. The depth of the USD’s underperformance earlier in the year implies that any rebound is more likely a correction than a reversal. The 1.6% single-day move in favour of the dollar may appear dramatic, but contextually it’s rooted in a combination of technical flow and provisional relief rather than a shift in macro fundamentals.

Monetary Policy Dynamics

In Japan, election season adds a layer of policy hesitation, especially regarding monetary tightening measures from the Bank of Japan. As such, there’s been a notable dampening of any imminent hawkish expectations, despite periodic yen strength. That resilience has partly reflected the absence of urgency more than the presence of renewed investor conviction. Should fiscal discussions around Japan’s defence and investment roles with the US advance meaningfully, adjustments to existing trade discounts could trigger liquidity-driven moves.

We see limited scope for continued yen depreciation under the current valuation, particularly if U.S. economic signals, such as PMIs or employment numbers, begin to falter. That would challenge the legs of the current USD rally, especially given how tied recent flows have been to sentiment around trade and risk. Moreover, any renewed pessimism about U.S. economic resilience would likely ignite calls for lower yields, stifling further upside in the pair.

Looking to the quarters ahead, expectations remain anchored—for now—around the 140.00 level. But should diplomatic proceedings between Tokyo and Washington evolve into a tangible framework, the pricing mechanism will begin to factor in long-term stability rather than short-term positioning swings. Those scenarios would demand rapid adjustment in exposure. A technical break lower in the pair triggered by treaty-driven capital realignments could test the durability of long dollar bets.

Participants should keep a close watch on correlations with equity risk and rates volatility, particularly as both Tokyo’s political structure and Washington’s trade rhetoric continue to influence capital flow. Our monitoring of implied volatility skews suggests investors may be underpricing downside risks as the time horizon moves past the current quarter. It remains to be seen whether risk appetite can sustain present levels without further reassessment of the fiscal and trade direction from either side.

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