Middle East Tensions Subdue Asia FX, Yen Near Four-Decade Low

Asian currencies traded in narrow ranges on Friday as escalating tensions in the Middle East curbed appetite for riskier assets, offsetting support from a softer U.S. dollar. The Japanese yen, meanwhile, remained pinned near a four-decade low despite renewed intervention warnings from Tokyo. Global markets are closely monitoring geopolitical risks, alongside U.S. inflation data and central bank monetary policy stances.

Hostilities between the United States and Iran intensified on Thursday with fresh military strikes, underpinning the dollar due to safe-haven demand. These developments kept oil prices near one-month highs, reinforcing concerns that higher energy costs could complicate the inflation outlook. Geopolitical risks, such as Iran's threats to close the Strait of Hormuz, also remained a focal point for markets.

The U.S. Dollar Index (USDIDX) had edged down to a one-month low earlier this week as softer-than-expected U.S. inflation prompted traders to pare expectations of another near-term Federal Reserve (Fed) rate hike. However, safe-haven demand stemming from Middle East tensions helped the dollar stabilize and finish the week largely unchanged. Analysts noted that the dollar's role as the highest-yielding safe-haven currency suggests markets are operating within a 'USD smile' framework.

The Japanese yen continues to face downward pressure due to the wide gap between U.S. and Japanese interest rates. The USD/JPY pair hovered around 162.4, leaving the yen close to the four-decade low of 162.84 touched earlier this month. Prime Minister Sanae Takaichi's fiscal spending plans have also weighed on sentiment. Japanese Finance Minister Satsuki Katayama reiterated that authorities stand ready to respond to excessive currency moves, keeping markets alert to the risk of official intervention. Japan spent a record ¥11.73 trillion supporting the yen between late April and late May.

Across Southeast Asia, currency movements were mixed. The USD/SGD pair was little changed after Singapore reported a narrower trade surplus and slower growth in non-oil domestic exports. The USD/MYR pair rose about 0.3% after Malaysia's annual inflation slowed to 1.9%, below expectations, suggesting Bank Negara Malaysia has room to keep policy settings unchanged. The Australian dollar (AUD) edged lower against the U.S. dollar as deteriorating risk sentiment outweighed the softer dollar. Meanwhile, the Chinese yuan was poised for its third consecutive weekly advance.

Moving forward, investors will turn their attention to next week's regional policy meetings and economic releases, including China's loan prime rate decision, Japan's inflation and trade data, and Bank Indonesia's policy meeting. Analysts at DBS expect the People's Bank of China (PBOC) to leave benchmark lending rates unchanged, while Bank Indonesia is forecast to raise interest rates by 25 basis points to support the rupiah amid higher oil prices and renewed geopolitical uncertainty. The Bank of Japan (BOJ) is expected to continue gradually normalizing monetary policy.