Recently, I’ve been closely watching the USD/JPY currency pair and noticed some very noteworthy developments.

Last week, USD/JPY surged straight to 159.85, just a little short of the psychological level at 160. Japan’s Finance Minister, Kaya Yamaguchi? (actually “Kaya”?)—no, it was Shinzō Katō—had repeatedly hinted that Japan would intervene, but the market still kept pushing higher all the way. You know what? The real driver behind this is the direct impact of the Middle East situation.

Negotiations fell apart. Last Sunday, the U.S. and Iran delegations held the highest-level face-to-face talks since 1979 in Pakistan, but they still failed to come up with anything. More importantly, the U.S. Central Command announced a maritime blockade of Iranian ports, which directly cut off Iran’s oil exports. Think about what that means—last month, the Strait of Hormuz had daily average oil exports of about 1.7 million barrels, and now this route has been blocked.

WTI crude oil jumped more than 10%, breaking through the 100 level in one move and reaching $105.6. A research report from the Commonwealth Bank of Australia pointed out that such a blockade would further intensify conflicts in the Middle East, and that in the physical market, benchmark oil prices have already shown that trading prices in the coming weeks could exceed $140 per barrel.

For Japan, this is just adding insult to injury. Rising oil prices directly push up Japan’s import costs, and Middle Eastern countries account for 95.9% of Japan’s crude oil imports. As a result, Japan’s 10-year government bond yield surged to 2.5% on Monday, hitting a 29-year high. The Bank of Japan is certainly considering raising interest rates, aiming to support the yen to curb price increases—but there’s a big problem here.

What Japan is facing is imported inflation driven by the supply side, not demand overheating. According to Bank of Japan data, in March, the average exchange rate of the yen versus the U.S. dollar depreciated by about 33% compared with the oil price peak in 2008. In that month, the yen-denominated crude oil price rose by about 9,500 yen per barrel versus the previous month. You see, yen depreciation and rising oil prices create a vicious cycle.

If the Bank of Japan were to raise interest rates sharply in the short term, it could trigger a reversal of carry trades—an event with potential “gray rhino” implications for the global economy. Also, in the U.S., March CPI rose 0.9% month over month, the largest single-month increase since June 2022. Gasoline prices even posted a record not seen since 1967. This means the likelihood of the Fed cutting rates within the year is also decreasing, and capital will keep flowing into the U.S. dollar as a safe haven.

Japan’s former senior foreign exchange official, Takehiko Nakao, had previously warned that intervening in the FX market by relying only on foreign exchange reserves can only deter in the short term. To truly rein in yen depreciation, the Bank of Japan must raise interest rates steadily to create policy coordination. But the reality right now is that the resistance to the Bank of Japan implementing large rate hikes is too strong.

From a technical perspective, the daily chart of USD/JPY shows the overall uptrend is still in good shape. Over the past month, it has been consolidating below the 160 level, and there is strong bullish momentum. Once it breaks above 160, it could further challenge the 163 level. To reverse the uptrend, it would first need to fall below 157.0.

My view is that if the Middle East situation can’t be eased in the short term, USD/JPY will very likely break above 160 and even move toward 163. In the process, Japan’s imported inflation and the vicious cycle of yen depreciation will become increasingly apparent, and the impact on global financial markets should not be underestimated.