The yen soared on Tuesday after the Bank of Japan decided not to announce additional measures to curb recent volatility in the bond market, spurring doubts about its commitment to easy money and causing steep losses in the Japanese stock market.
Japan's currency gained more than 3 percent to hit 95.60 yen per dollar after the BOJ held off extending the maximum duration of its fixed-rate loans. Some had expected it to stretch the duration to two years from one.
This prompted investors to unwind some of the hefty bets against the yen they placed after the BOJ announced a $1.4 trillion stimulus program in early April. Japan's Nikkei index, with which dollar/yen has been closely correlated in recent weeks, closed down 1.5 percent.
(Read More: Dollar-Yen Shake-Out Could Just Be the Start)
The BOJ's restraint had a global impact as well, causing world equity markets, bond prices and commodities to slump as investors feared that major central banks are cooling their commitment to the money-pumping that has buoyed markets.
"The BOJ's announcement was not necessarily significant, but headed into the meeting there was some hope they would extend the lending terms and they disappointed on that end," said Vassili Serebriakov, foreign exchange strategist at Wells Fargo in New York.
The dollar last traded at 95.99 yen, down 2.8 percent on the day.
"When it comes down to it, the BOJ announcement was not the main catalyst for the yen's rise, but rather a general risk-off environment stemming from a slide in higher-yielding emerging-market currencies," he said.
Many investments in these emerging-market currencies were funded in yen, which can be borrowed for interest rates that are among the lowest in the world.
In the options market, one-month dollar/yen implied volatility, a measure of expected price swings and a gauge of options pricing, traded near its highest level in more than a year at around 15 percent.
More yen gains could see the dollar drop toward 95.96 yen, the bottom of the daily Ichimoku cloud—a closely followed technical indicator—and Friday's low of 94.975 yen.
"What we are seeing is position-squaring in a highly volatile environment and we could retest the June lows of 95/96, but ultimately that will be a buying opportunity, and we forecast dollar/yen at 108 by the end of the fourth quarter," Serebriakov said.
Most analysts expect yen weakness to return as the BOJ's aggressive stimulus is contrasted eventually with the U.S. Federal Reserve's asset-purchase program. Last week's relatively healthy U.S. nonfarm payrolls report has spurred expectations that the Fed will start reducing its monthly purchases of $85 billion per month later this year.
The Fed's bond-buying program is viewed as negative for the dollar as it is tantamount to printing money.
The euro fell as low as 127.16 yen and last traded at 127.79 yen, down 2.4 percent on the day.
Germany's Constitutional Court, meanwhile, started a two-day hearing on the legality of the European Central Bank bond-buying scheme that has defused the euro zone debt crisis.
A ruling is not expected until after German general elections in September, but investors were nervous that Bundesbank chief Jens Weidmann, who will attend the court hearing, could reiterate his opposition to the ECB program.
The euro rose after European Central Bank executive board member Joerg Asmussen told the court that the ECB's bond-buying scheme must be unlimited to show the ECB is serious about defending price stability but is in effect limited by its focus on shorter maturity bonds.
The euro traded as high as $1.3314 shortly following his remarks, its highest since late February. Gains were pared headed into Europe's stock market close, with the euro last trading at $1.331, up 0.4 percent on the day.
The euro earlier found support after Germany's economy ministry said the economy picked up in the second quarter.
Having bumped up against and retested major resistance at $1.33, euro/dollar is now at a critical juncture, according to James Chen, chief technical strategist at City Index Group.
"A strong breakout above $1.33 would clearly confirm a bullish trend continuation, with further upside resistance targets around $1.35 and then $1.37," he said.
"If $1.33 is respected as resistance with a turn back to the downside, the major intermediate support objective remains around the key $1.30 level," he said.
Meanwhile, the higher-yielding Australian dollar slid sharply to hit its lowest since September 2010 at $0.9324, according to Reuters data. It was last at 0.9433, down 0.3 percent on the day.