USD/JPY remains stable near yearly highs as geopolitical risks, Fed policy loom

USD/JPY trades around 158.90 on Thursday at the time of writing, showing little change on the day. The pair remains close to its yearly highs, supported by a relatively firm US Dollar (USD) despite a tense geopolitical backdrop and growing expectations that Japan may gradually normalize its monetary policy.

Geopolitical developments in the Middle East are drawing strong market attention. Iran has launched what it described as its most intense operation since the beginning of the war, notably attempting to disrupt traffic through the Strait of Hormuz, a crucial passage for global Oil flows. At the same time, the Israel Defense Forces announced a wide-scale wave of strikes targeting Hezbollah infrastructure. In this environment, traders are closely monitoring the evolution of the conflict, as any escalation involving Iran, its regional neighbors, the United States (US) or Israel could strengthen demand for safe-haven assets such as the Japanese Yen (JPY) and weigh on USD/JPY in the near term.

On the macroeconomic front, data released Wednesday by the Bureau of Labor Statistics showed that the US Consumer Price Index (CPI) rose 0.3% MoM in February, compared with 0.2% previously, in line with market expectations. Core inflation, which excludes volatile food and energy prices, increased by 0.2% MoM after a 0.3% rise previously, also matching forecasts. Market participants largely looked through the report and instead focused on rising Oil prices, which could push headline inflation higher in the coming months.

Markets now widely expect the Federal Reserve (Fed) to keep interest rates unchanged at its upcoming policy meeting on March 18. However, the outlook for energy-driven inflation and persistent geopolitical risks continues to provide support for the US Dollar.

Several financial institutions are urging caution at current levels. Analysts at DBS note that the pair is testing an important resistance zone around 159-160, while the Bank of Japan (BoJ) could deliver a hawkish hold at its March 19 meeting as it continues its path toward policy normalization. According to DBS, a diplomatic de-escalation in the Middle East, potentially linked to upcoming discussions between the US and China, could lower energy prices and weaken the current fundamental support for USD/JPY.

Meanwhile, analysts at MUFG argue that rising energy prices represent a negative terms-of-trade shock for Japan, which may lead authorities to tolerate a weaker JPY in the near term. This situation could raise the threshold for foreign exchange intervention, even as expectations grow that the Bank of Japan could deliver another rate hike as soon as April.