Risk Appetite or Risk Trap? Markets React to Middle East Escalation

Despite all the noise, the Bank of Japan played it safe. The policy rate stayed at 0.50%, and they merely tweaked their bond-buying program, saying they’ll slow down the pace starting April 2026. Nothing major, and the FX market shrugged USDJPY barely moved, still hovering just under 145. The real takeaway? The BoJ is walking a tightrope. Governor Ueda made it clear that uncertainty especially from global trade and geopolitical tensions is keeping the bank from tightening more aggressively. Unless we see a sudden surge in inflation or a major shift in global risk appetite, the yen's path will remain tied to external factors namely, long-end yield spreads and safe-haven flows.

As Expected, no Changes Were Made for BOJ as Forex Traders Still Holding Short on JPY

Now, zoom out to the broader battlefield literally.

The Israel-Iran conflict remains the biggest wildcard on traders' radars. Over the weekend, markets took some relief in reports that Israel hadn’t struck Iran’s oil infrastructure at least, not yet. Oil prices briefly dropped back below $71 before bouncing toward $75 overnight, a sign that traders are playing this one hour by hour.

Oil Prices Soar During NY and London Session as Commodities Traders Continue to See Risk into the Israel and Iran Attack 

But this is no lull. Behind the scenes, Iran is reportedly reaching out via Arab intermediaries, signalling openness to resume nuclear talks if the U.S. stays out of the strikes. Meanwhile, Israel isn’t budging. Officials are planning at least two more weeks of military operations, clearly aiming to dismantle Iran’s missile and nuclear capabilities.

President Trump who left the G7 early to “attend many important matters” isn’t helping calm the waters. His social media tirade over Iran “wasting human life” and reiterating “IRAN CAN NOT HAVE A NUCLEAR WEAPON” is escalating the rhetoric, if not the conflict itself.

Bottom line: the market is still pricing in hope, not escalation. There’s a fragile belief that as long as oil keeps flowing, risk appetite can survive. That’s a dangerous assumption.

What does that mean for the dollar and risk assets?

The USD is weaker this week, with high-beta G10 currencies like AUD and NZD catching a bid as risk sentiment improves. But let’s be honest this isn’t confidence, it’s complacency. The lack of an oil shock has lulled markets into a sense of temporary calm, but if we get even one confirmed strike on energy infrastructure or pipelines, this all turns fast. A sustained rally in crude above $80 would likely reignite USD (DXY) demand on global growth fears and boost safe haven flows into the dollar and the yen.

Also keep in mind: US retail sales are coming in today. Any signal of consumer weakness especially after last month’s inflation surprise could reinforce bets that the Fed is done hiking and might even have to pivot sooner than expected. That would add fuel to the dollar sell-off.

My positioning mindset right now?

I'm already long USDJPY, looking for a resumption of yen weakness if bond spreads widen again. But I’m also watching for tactical opportunities to fade risk-on rallies in AUDUSD or NZDUSD especially if oil spikes again or geopolitical risk re-escalates.

If things flare up further in Tehran or if Trump hints at US intervention watch gold and oil rip higher. And watch USDCHF and USDJPY diverge: the franc may outperform as a geopolitical haven, while the yen’s safe-haven status remains muted unless Japan’s own data deteriorates.

Q1: Why didn’t the Bank of Japan’s decision move USDJPY significantly?
A1: Because markets expected no change. The BoJ held rates steady at 0.50% and only slightly adjusted its bond-buying program news that was already priced in. Without a surprise or shift in forward guidance, traders saw little reason to reprice the yen. The real driver of USDJPY remains U.S.-Japan yield differentials and global risk sentiment, not BoJ tweaks.

Q2: How does the Israel-Iran conflict affect currencies and commodities?
A2: It introduces event-driven volatility. Traders are watching for any escalation that could disrupt oil supply. A direct hit to Iran’s energy infrastructure could send crude prices soaring past $80, triggering safe-haven demand for the USD and CHF. In contrast, temporary de-escalation or diplomatic progress tends to lift risk assets like AUD, NZD, and EMFX.

Q3: Why is the U.S. dollar weakening despite geopolitical tensions?
A3: Because markets are currently betting on a soft-landing scenario. With no immediate oil shock and signs of slowing U.S. inflation, investors are reducing bets on further Fed hikes. This “relief rally” in risk assets is weakening the dollar but it’s fragile. A geopolitical flare-up or poor U.S. retail data could flip sentiment quickly.

Q4: What would cause oil to spike sharply from here?
A4: A confirmed strike on Iranian energy infrastructure, disruption to regional pipelines, or U.S. military involvement. Any of these would likely push crude back above $80 and potentially into triple digits depending on the scale of damage or intervention. This would amplify inflation fears and force a repricing of risk across FX and commodities.

Q5: What’s the biggest market mispricing right now?
A5: Complacency around energy risk. Markets are assuming oil flows will remain uninterrupted, despite escalating rhetoric and military activity. If this assumption is wrong, we could see a sharp reversal in risk assets and renewed demand for USD and hard commodities. Traders should be hedged for tail risk.

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