The FX market looks set to be buffeted by a trifecta of issues

Risk assets in Asia have started the week on the back foot while the US dollar starts on the front foot. Many Asian currencies face a triple threat from the conflict in Iran, AI-stock meltdown and growing expectations of tighter Fed policy. While this is primarily playing out in the emerging market space, it is infecting G10 currencies as well.

For instance, it is hard to see how the Bank of Japan can hold the line at 160 for the US dollar/yen if Asian currencies are collapsing around the BoJ’s ears. Japan, like others in the region, is heavily dependent on the Strait of Hormuz for its energy supplies even if imports come indirectly from other Asian countries. Japan might be less sensitive to any AI-stock-related meltdown than many other Asian countries, but stocks have more than doubled over the past year on the Nikkei index and hence could be very vulnerable to a significant correction. Rising US rates also pose a threat, with last Friday’s blowout payroll release from the US, the latest economic data, to pile on the pressure for a tighter policy stance from the Fed.

Hence, all three factors could easily lead to a sustained break of the 160 level against the US dollar that the BoJ appears keen to defend. More intervention may be forthcoming, but dollar/yen bulls are unlikely to be scared of this prospect given the collapsing Asian currency backdrop. The BoJ could opt for a more aggressive policy-rate response at the June 16th meeting with a 25-bps increase already discounted by the market, but we think that unlikely. It seems that the most likely outcome is for dollar/yen to trade modestly above the 160 level with intermittent intervention from the BoJ to remind the market that it is not happy with the yen’s weakness.

The same three factors that we’ve listed as weakening Asian currencies threaten others as well. Dependency on imported energy, AI stock booms and vulnerability to tighter Fed policy are evident everywhere. This being said, we might want to question what sort of lift the dollar can get from these factors on a global level.

For instance, the conflict in Iran has been going on for 13 weeks now, and energy prices have surged, and yet the US dollar is barely any higher now against other G10 countries than when the war started. Another point is that AI-related stock strength is also very prevalent in the US. If weakness here causes a rush of US dollar hedging by overseas investors, the US dollar could fall, just as it did in the spring of 2025 when President Trump’s tariffs caused a slump in stocks. And finally, on Fed policy, any move to tighten monetary conditions would only leave the bank on an equal footing with many other central banks who are also likely to hike rates.

Worse still, if the Fed holds the line with stable policy rates while the likes of the ECB, BoJ, and BoE hike, it could undermine the US dollar. The ECB is expected to hike rates this week, a move that will uphold its reputation as one of the most inflation-conscious central banks. Steven Barrow, head strategist of the Standard Bank, said it is the strong anti-inflation reputation of the ECB that has kept the euro on a firm upward path for most of its 27-year history.

When we take into account these potential impediments to US dollar strength within the G10, it leaves us feeling that we are looking, at most, at a period of modest dollar strength, not a runaway rally. As we’ve said, the US dollar/yen could start to trade consistently a few yen above the 160 ‘boundary’ that the BoJ had set. The euro is seen pushing down towards the lower end of a 1.10-1.15 range with sterling/US dollar sliding into the 1.25-1.30 region.

“This does not represent dramatic strength for the US dollar, and we remain reticent to change our longer-term call for modest dollar weakness, which is in place due to more longer-term structural drivers relating to issues such as the decline we expect in the dollar’s global position. Indeed, the thing that is very notable in our view right now is that the one currency that seems likely to challenge the US dollar over the long haul—the renminbi—is still rising against the US dollar even as the US dollar makes gains elsewhere," said Steven Barrow.