Risk Appetite Improves
Risk sentiment improved on expectations that conflict in the Middle East may not widen. This followed a statement from US President Trump that he instructed the Department of War to pause attacks on Iran’s power plants for five days. Iran rejected reports of direct talks with the US on de-escalation. Despite this, comments from Trump supported expectations of a possible resolution. In Japan, the Yen found support after Bank of Japan remarks pointing to moderately rising inflation pressures. Governor Ueda said underlying inflation is expected to accelerate moderately, citing a tight labour market and wage and price-setting behaviour. Japan’s National CPI excluding fresh food for February rose 1.6% year-on-year. This was below forecasts of 1.7% and the prior reading of 2%.Volatility Outlook
The improving risk appetite, driven by the pause in Middle East hostilities, is putting pressure on the Yen’s safe-haven status. We see this renewed confidence in the S&P 500 futures, which indicates capital is flowing away from safety and into riskier assets. This environment typically favors selling the Yen to fund carry trades, especially against currencies with higher interest rates. However, we must weigh this against the Bank of Japan’s confident stance, which is being backed by real data. Following the recent “Shunto” negotiations where major firms agreed to average wage hikes of over 4.3%, the highest in decades, the BoJ’s inflation narrative is gaining credibility. Traders should consider buying JPY call options or selling USD/JPY futures to position for a potential interest rate hike sooner than the market expects. Looking back, we saw similar situations in 2025 where strong verbal commitments from Japanese officials led to sharp, but brief, rallies in the Yen. The core driver then, as it could be now, was the wide interest rate gap between Japan and the US. Therefore, using option structures like put spreads on the JPY could protect against a temporary spike while maintaining a bearish outlook if the BoJ fails to act decisively. The conflicting signals between weak inflation data and strong wage growth suggest a period of high volatility is approaching. One-month implied volatility for USD/JPY has recently fallen to 8.5%, making option straddles relatively inexpensive. We believe this presents an opportunity to trade the impending breakout, as the pair is unlikely to stay in this tight range when monetary policy and geopolitical risks are pulling in opposite directions. Create your live VT Markets account and start trading now.
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