USD/JPY pushes past 158 as 2 drivers boost dollar

The dollar surged against the yen on Tuesday, breaking above the 158 level, as traders priced in persistent geopolitical risk from the Middle East and signs of continued strength in the US economy, diminishing hopes for near-term Federal Reserve rate cuts.

"Geopolitics certainly matter, but more often than not, flare-ups produce buying opportunities rather than prolonged bear markets," said David Kletz, Vice President and Lead Portfolio Manager at Forstrong Global Asset Management. "By anchoring to a single storyline, they miss the feedback loops. Markets are not driven by isolated shocks, but by the interaction of forces."

The market reaction was broad, reflecting a flight to the dollar. The USD/JPY pair climbed to its highest level in decades, while oil prices remained elevated, with Brent crude trading near $95 a barrel. Gold, another traditional safe haven, saw volatile trading, dipping to around $4,797 an ounce as the dollar gained strength. US equities paused their rally, with the S&P 500 slipping 0.2% from its recent all-time high as investors weighed the dual headwinds of geopolitical tension and the prospect of higher-for-longer interest rates.

The dynamic creates a complex challenge for policymakers globally, particularly in Tokyo. A persistently strong dollar tightens financial conditions for countries with dollar-denominated debt, while a weak yen fuels import-driven inflation in Japan, putting pressure on the Bank of Japan just as it begins to normalize policy after decades of stimulus.

Geopolitical Risk Premium Returns

The primary driver of the dollar's strength is the escalating situation in the Middle East. With a fragile two-week ceasefire between the United States and Iran set to expire Wednesday evening, uncertainty is roiling energy markets. Doubts remain over whether Iran will participate in a new round of peace talks hosted in Pakistan, according to multiple reports. The US has signaled it is unlikely to extend the truce, with President Trump stating the US blockade on the Strait of Hormuz—through which roughly 20% of the world's oil supply passes—will remain until a deal is reached.

This disruption has injected a significant risk premium into oil prices, feeding concerns of a second wave of inflation just as central banks were gaining confidence. "The oil shock has come at an inconvenient moment for policymakers," said Brian Arcese, a portfolio manager at Foord Asset Management. "Fears of stagnant growth, job losses and rising prices... are perhaps overblown for now," but the situation complicates central bank policy and squeezes household spending.

Diverging Economic Paths

Compounding the geopolitical driver is the widening divergence between the US and Japanese economies. The US continues to show remarkable resilience, with robust consumer spending and strong first-quarter corporate earnings, according to several major banks. This strength supports the Federal Reserve's case for holding interest rates steady, with some officials even acknowledging a renewed tilt toward inflation risk.

In contrast, Japan's economy remains fragile. While the Bank of Japan has officially ended its negative interest rate policy, the wide differential between US and Japanese government bond yields continues to make the dollar a more attractive investment. The strengthening dollar is not isolated to the yen; the Singapore dollar, another currency seen as a regional safe haven, has also hit record highs against several Asian currencies, supported by its central bank's hawkish policy stance.

For investors, the lesson is to look beyond a single narrative. "The most effective defense is structural: Avoid concentration risk, remain broadly diversified, and keep portfolios aligned with underlying growth drivers," Kletz of Forstrong advised. While geopolitical flare-ups capture headlines, long-term returns are ultimately driven by a wider set of economic fundamentals that reassert themselves once the spotlight moves on.

This article is for informational purposes only and does not constitute investment advice.