USD/JPY traded firmer near 158.55 in early Asian trade on Tuesday, as the Japanese Yen weakened after a softer inflation print. Markets are awaiting the preliminary US S&P Global PMI reading for March, due later on Tuesday. Japan’s National CPI rose 1.3% year on year in February, down from 1.5% in the prior reading. This was the lowest level since March 2022 and remained below the central bank’s 2% target.

Japan Inflation Details

National CPI excluding fresh food increased 1.6% year on year in February, easing from 2.0% and below the 1.7% consensus. “Core-core” inflation, which excludes fresh food and energy, rose 2.5% year on year, down from 2.6%. Markets are also watching developments in the Middle East, where higher tensions could affect energy prices and inflation expectations. Bloomberg reported that US President Donald Trump offered Iran a five-day reprieve and referred to possible talks, which Iranian officials denied. Mohsen Rezaei, a senior military adviser to Iran’s Supreme Leader Mojtaba Khamenei, said the war would continue until Iran receives full compensation for damage sustained. The situation remains a focus for near-term currency moves. Looking back at this time in 2025, we remember the concerns about Japanese inflation coming in cooler than expected, which helped push the USD/JPY pair towards 158.55. Today, with the pair now trading near 165.20, that dynamic has only intensified over the past year. The fundamental story of a weak yen remains largely intact, creating specific opportunities.

Policy Divergence Drives Dollar Strength

The core of this trend continues to be inflation and central bank policy divergence. The Japanese CPI data for February 2025 showed a low 1.3% rise, and even now, the most recent numbers for February 2026 show inflation is still struggling at just 1.8%, below the Bank of Japan’s 2% target. This contrasts sharply with the US, where inflation, while down from its peaks, has proven sticky, with the last CPI print for February 2026 coming in at 2.9%. This persistent gap in inflation and interest rates is what derivative traders must focus on. The Bank of Japan has only managed one small rate hike in the past year, while the US Federal Reserve has held rates steady, signaling a very cautious path to any potential cuts. This means the interest rate differential between the two countries remains exceptionally wide, favoring the dollar. For traders, this suggests that the positive carry from holding long USD/JPY positions is still highly attractive. Selling out-of-the-money JPY call options could be a prudent way to generate income, as a sudden and sustained surge in the yen’s value seems unlikely without a major policy shift from the Bank of Japan. This strategy capitalizes on the market expecting the pair to either drift higher or stay within a range. We must also watch for signs of intervention from Japanese officials, which become more likely as the pair stays above the 165 level. This risk is reflected in the options market, where one-month implied volatility has crept up to 9.5% from the 7.8% seen in late 2025. Buying short-term, cheap JPY call options could be a smart hedge against any surprise announcements from Tokyo. While the specific US-Iran talks that were a focus in early 2025 have faded from the headlines, broad geopolitical uncertainty continues to support the US dollar. Any flare-up in global risk tends to send capital towards the greenback. Therefore, holding some exposure to dollar strength against weaker currencies like the yen remains a sound underlying position. Create your live VT Markets account and start trading now.

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