Increasing Tensions in the China-Japan Conflict

The growing conflict between China and Japan, especially China’s export controls, has impacted economic forecasts. It’s hard to see a quick resolution or a rapid recovery of the Yen. Weak wage data in Japan makes it less likely that interest rates will rise. Those hoping for the Yen to strengthen need to anticipate a cooling of tensions and no more export restrictions from China. These uncertainties are creating more challenges for the Japanese currency in the short term. As we approach early January 2026, the trends from late last year are returning. The Japanese Yen continues to weaken, with USD/JPY nearing the 152.00 mark, a level that has previously raised alarms among officials. This decline is occurring even with a softer US dollar, which emphasizes the ongoing pressures on the Yen. The Bank of Japan plays a significant role in this weakness. Last year’s disappointing wage data supports the idea that rate hikes are unlikely soon. Real wages in Japan fell for more than 20 months until the end of 2025, giving the central bank little room to adjust policy. For traders, this suggests that any strength in the Yen should be viewed as a temporary reversal.

The Main Risk

The main risk affecting the market is the rising tension with China, which recently imposed export controls. This is a serious concern, as China had previously restricted rare earth exports to Japan in 2010 during a territorial dispute. The geopolitical uncertainty is likely keeping implied volatility high in the Yen options market. In this situation, buying USD/JPY call options for the upcoming weeks seems like a smart move. It allows for participation in potential Yen weakness caused by differing policies and geopolitical risks while clearly defining the maximum potential loss. Limiting risk is crucial in a market where sharp, unpredictable movements are becoming more frequent. However, we should be aware of the ongoing threat of intervention from the Ministry of Finance. Selling call options at higher strike prices, like around the 155.00 level, to create a call spread could effectively manage this situation. This strategy would benefit from a slow, steady decline in the Yen while also considering that officials may intervene to prevent a chaotic drop. Create your live VT Markets account and start trading now.

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