The yen swung in holiday-thinned market conditions, punching through ¥160 per dollar to touch its weakest in 34 years before erasing all its losses for the day and rebounding strongly.

The Japanese currency dropped to ¥160.245 per dollar on Monday before heading into the other direction to ¥155.01. Trade sources said Japanese banks were seen selling dollars for yen.

The moves, which took place amid thin liquidity due to a local public holiday, are a sign of nervous traders juggling the prospects of official intervention with the risks of hawkish comments by the Federal Reserve later this week.

"The market is very jumpy and with not a lot of liquidity, the yen becomes a sharp toy to play with,” said Rodrigo Catril, a strategist at National Australia Bank. "The risk of intervention is an added factor.”

The U.S. central bank is scheduled to hold a policy meeting during which it may signal the need to keep interest rates elevated amid sticky inflation — a move that would likely support the dollar and undermine the appeal of yen assets. But behind the fundamentals which point to a weaker yen is the risk that Japan steps into support its currency, as it did in 2022.

"Should there be no intervention, it would be dangerous to catch a falling knife, particularly with the Fed likely to signal a longer wait for cuts,” said Fiona Lim, senior strategist at Malayan Banking. "Momentum is definitely there for dollar-yen to move decisively above the 160 and markets are testing Japan’s tolerance for a sharp yen decline.”

The Bank of Japan last week indicated financial conditions will remain easy, though policymakers have repeatedly warned that depreciation won’t be tolerated if it goes too far too fast. Earlier this month, the nation’s finance minister also flagged concerns over the yen’s decline to U.S. Treasury Secretary Janet Yellen, which market participants saw as laying the groundwork for intervention.

Japan’s top currency official Masato Kanda has given an example of a ¥10 move over one month as a rapid one. Japan’s currency has weakened by about ¥8 per dollar over the last month, but it fell over 2% last week alone and is down more than 10% year-to-date.

Kanda declined to comment on Monday, when asked if authorities in Tokyo had intervened in the currency market to prop up the yen.

"I won't comment now," Kanda, the vice finance minister for international affairs, told reporters, when queried about market views that currency intervention caused a spike of ¥5 against the dollar in Asian trading.

"The speed and magnitude of the move from 160 to 155 with the lack of bounce suggests official intervention," said Prashant Newnaha, senior Asia-Pacific rates strategist with TD Securities in Singapore. "Timing couldn't have been better with low liquidity on a Japanese holiday.

"Prior intervention suggests a ¥5 move to 155 but if the MoF wants to send the message to the shorts that enough is enough, then a move towards 150-152 would send a clear message," Newnaha added.

Nicholas Chia, Asia macro strategist with Standard Chartered Bank in Singapore, said that if Monday's movement represents intervention by authorities, "is unlikely to be a one-and-done move."

"With FOMC and payrolls on the docket this week, we can likely expect more follow through from MOF if USD-JPY travels to 160 again. In a sense, the 160-level represents the pain threshold, or new line in the sand for the authorities."

But Japan has appeared reluctant to act. One reason for this may be that intervention alone cannot alter the wide gulf in interest rates that’s in part driving the yen’s decline. While the BOJ has brought local rates out of negative territory, they are still far from levels that would tempt investors from the higher yields on offer in the U.S. and other countries.

"The current pace of depreciation is less than in 2022 so the intervention response could be less intense,” wrote Vincent Chung, associate portfolio manager at T. Rowe Price. "Additionally, market participants have priced in the possibility of intervention by authorities following the BoJ meeting in May, as indicated by option pricing.”

Bets in the options market helped to exacerbate the yen’s drop on Monday, with barriers against the dollar and euro being targeted on the view intervention risks were likely low during a Japan holiday, according to Asia-based traders. Against the euro, the yen has fallen beyond ¥170 to the weakest since the creation of the common currency.

"Pressures will remain on the currency until we get more downbeat growth and inflation data in the U.S. and clearer hawkish shift at the BOJ,” said Homin Lee, senior macro strategist at Lombard Odier in Singapore. "We still think we are quite close to the Finance Ministry’s intervention, in light of the recent rhetoric on excessive currency market moves.”