Synopsis:

MUFG highlights the underperformance of the Japanese yen this week, driven not by domestic policy surprises but by broader geopolitical risks and rising global inflation expectations. Despite the tense backdrop, USD/JPY has moved modestly higher, while overall FX volatility remains subdued.

Key Points:

• JPY Underperformance:
  The yen is the third weakest G10 currency this week, behind only the SEK and NOK, which were hit by dovish central bank rate cuts.

• BoJ Impact Muted:
  The Bank of Japan’s meeting this week contained no major surprises, and policy continuity kept JPY reaction muted.

• Geopolitical Drivers:
  Market attention shifted to rising Middle East tensions—specifically, the Israel-Iran conflict—and the possibility of US military involvement within a two-week horizon. This elevated risk sentiment but didn’t spark a large USD rally.

• USD/JPY Higher on Oil and Yields:
  Rising crude oil prices have added to inflation expectations, supporting US Treasury yields, which pushed USD/JPY higher by just over 1 figure.

• Limited UST & FX Market Reaction:
  Despite the narrative of rising inflation risk, US 2-year yields are flat on the week, suggesting markets are not pricing in a Fed shift. This has limited the scope of yen depreciation.

• Volatility Still Subdued:
  MUFG’s G10 FX Volatility Index inched up to 9.1% but remains below its long-run average (10.2%), highlighting continued investor calm despite geopolitical risks.

Conclusion:

MUFG sees JPY lagging in part due to oil-driven inflation concerns and limited yield curve moves in the US. While geopolitical tensions raise headline risks, the muted reaction in rates and volatility markets keeps USD/JPY trading in a controlled range. Without a sharp move in UST yields, a significant JPY reversal is unlikely.