Shaken by the prospect of nuclear meltdown after a devastating earthquake and tsunami, Japanese investors will dump overseas assets on Monday and bring their money home to help finance reconstruction.
Positioning for this could send the dollar plummeting versus the yen on Monday and lead to a sharp slide in Treasuries since U.S. government bonds are a favorite asset of Japanese investors, market analysts said.
Stocks also are likely to come under pressure.
Japanese insurers will probably sell some of their most liquid foreign assets such as U.S. Treasuries so they can respond to the worst disaster since World War Two.
The crisis could lead to insured losses of nearly $35 billion, risk modeling company AIR Worldwide said, making it one of the most expensive disasters in history and nearly as much as the entire worldwide catastrophe loss for the global insurance industry.
Traders braced for just such an outcome on Friday, when the yen surged and Treasuries fell. The Bank of Japan probably will add money to the system to limit the liquidation of assets. But the big question remains of how much follow-through selling is yet to come.
Dan Fuss, the vice chairman of $150 billion Loomis Sayles, told Reuters on Sunday that his best guess is that Treasuries will continue to see losses.
Because Japan is the second-biggest holder of U.S. government debt and they have nearly $900 billion in dollar reserves, Fuss said Japan will likely use reserves for rebuilding.
A big buyer of bonds is taken out of the market, Fuss said, adding that Japan will be less able to add to their reserves and less able to buy Treasuries.
Japan's crisis may also provide a new reason to press on with the long-awaited retreat in stocks.
A lot will depend on the price of oil, which fell on Friday on concern that the Japanese earthquake would hit global economic sentiment. It came off recent highs reached on the revolts in North Africa and the Middle East, but upheaval in the region over the weekend continued -- notably with a protest in Saudi Arabia.
Investors will also engage in the grim exercise of determining which companies will benefit from helping the world's third largest economy rebuild.
You could expect to see industrial infrastructure companies do better. As for the overall markets, I don't see it having any long-term negative impact, said Paul Hickey, co-founder of Bespoke Investment Group.
I remember after the last big tsunami in Indonesia there was a widespread view that it would be devastating, but there were no big impacts. Granted this is a much more developed region and certain insurance companies will have bigger exposure than others but outside of that region business will continue to go on.
Equities have generally remained relatively resilient amid a wide range of risk factors in recent weeks. World stocks <.MIWD00000PUS> have come off highs, but are still clinging to year-to-date gains, thanks primarily to the developed markets.
Prime Minister Naoto Kan described the crisis as Japan's worst since 1945, as officials confirmed that three nuclear reactors were at risk of overheating, raising fears of an uncontrolled radiation leak.
The disaster may also put some pressure on the Bank of Japan, which said it was cutting short its upcoming two-day meeting to just Monday.
It can do little with rates per se, even if it wanted to, because the current target is just 0.05 percent. It has, however, promised to ensure market stability.
FIGHTING YEN STRENGTH
Many expect the Bank of Japan to pump even more liquidity into the system, and for the government to try to fight any rise in the yen. A strong yen would add to the economic woes of export-dependent Japan as it struggles to recover from the disaster.
I believe we have reached a critical point where the disaster is so severe the BOJ will engineer liquidity mechanisms that will reduce the likelihood of forced selling in the Treasury market, said Christian Cooper, head of U.S. dollar derivatives trading at Jefferies & Co. in New York.
Even if the BOJ does undertake massive liquidity injections, an action expected before the U.S. Treasury market opens on Monday, most analysts still expect to see further selling pressure on U.S. Treasuries, at least initially.
Japan's stock market, meanwhile, has been something of a favorite with global investors this year. The broad TOPIX index was up more than 8.5 percent for the year in mid-February before the recent pullback and Friday's quake-related sell-off.
Analysts suggested that companies based in and around the main damage area could suffer losses on Monday but that construction firms would get a boost.
Electronics giant Sony Corp <6758.T> has suspended operations at eight factories. Nissan Motor <7201.T> halted output at all four of its domestic a assembly factories and said restarting them could depend on whether it can get parts.
Losses could be limited though. Financial markets bounced back fairly quickly after the 1995 quake that devastated Kobe and caused $100 billion in damage.
(Reporting by Jennifer Ablan and Burton Frierson in New York, Jeremy Gaunt in London)