Japanese Yen struggles to gain traction despite softer US Dollar

USD/JPY holds firm on Monday as traders track rapidly changing headlines from the Middle East. Lingering concerns about another intervention by Japanese authorities also limit the pair's upside as the Japanese Yen (JPY) once again tests the 160.00 level against the US Dollar (USD).

At the time of writing, the pair trades around 160.15, virtually unchanged on the day.

Iran's Fars News Agency reported that Iran had ended its military operations against Israel. The development followed an exchange of strikes between Iran and Israel over the weekend, the first since the ceasefire announced in April.

Meanwhile, US President Donald Trump sought to reassure markets by saying that peace talks between the United States and Iran are still ongoing, while warning that the US naval blockade of Iranian ports would remain in place until a final deal is reached.

In reaction, the US Dollar weakened as improving risk sentiment helped the Japanese Yen regain some ground. The US Dollar Index (DXY), which tracks the Greenback's value against a basket of six major currencies, is trading around 99.96 after touching 100.21 earlier, its highest level since early April.

However, the downside in USD/JPY appears limited as the fundamental backdrop surrounding the Japanese Yen remains weak.

Why is the Yen weak?

The Japanese Yen has erased all of the gains triggered by Tokyo's intervention in late April, when the currency weakened beyond the 160.00 level. Reports showed that Japan's Ministry of Finance spent a record ¥11.735 trillion supporting the Yen between April 28 and May 27.

The US-Iran war has boosted demand for the US Dollar while adding pressure on energy-importing economies such as Japan. More than 90% of Japan's crude Oil imports come from the Middle East, leaving the Japanese Yen highly exposed to elevated Oil prices and supply disruptions.

The wide interest rate differential between the United States and Japan continues to favor the US Dollar. In addition, the recent surge in Oil prices has increased upside risks to inflation, fueling expectations that the Federal Reserve (Fed) may need to raise interest rates again.

Such a move could further widen the interest rate gap, given the Bank of Japan's (BoJ) slow pace of policy normalization.

What's ahead?

Traders are bracing for US inflation data due later this week ahead of the central bank decisions next week. Markets are fully pricing in a rate hike from the BoJ, while the Fed is widely expected to leave interest rates unchanged.

Beyond the decisions themselves, markets will be watching for clues on the future policy path of both central banks. Any indication that the Fed could keep rates higher for longer, or that the BoJ will remain cautious about further tightening, could drive the next move in USD/JPY.