March 13, 2011 / 9:15 PM / in 8 years

Will Japan dump U.S. bonds for disaster costs?

NEW YORK (Reuters) - Investors in the Treasury market will begin this week confronting the familiar specter of possible post-disaster selling of U.S. Treasuries by insurers, following the devastating earthquake in Japan on Friday.

But not everyone in the market is convinced that worries over insurer selling are grounded in reality, and analysts pointed to a host of other issues that could drive Treasury price movements in the coming week.

In Japan, worries that insurance companies would need to sell Treasuries to raise cash may give way to a flight to safety into U.S. government bonds if the threat of nuclear meltdown persists.

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.

“I would assume repatriation fears may prove the initial motivation, but should the flows not materialize we risk a grinding bid on nuclear accident flight-to-quality jitters as well as the ongoing turmoil in the Middle East,” said Ian Lyngen, a senior government bond strategist at CRT Capital.

The U.S. Federal Open Market Committee will hold a one-day meeting on Tuesday that will be closely watched for signs that the Fed could start to dismantle its “extended period” language, a pledge to keep monetary policy loose for the foreseeable future.

And two U.S. economic data points will offer important indications of current inflation trends, while on Wednesday housing starts data will provide a look at one of the two sectors — housing and employment — that are said to be lagging in the economic recovery.

To start, though, traders will take stock of the latest news from Japan, where authorities were struggling to care for millions of people without power or water, three days after an earthquake and tsunami killed an estimated 10,000 people or more in the country’s darkest hour since World War Two.

Still, short of a nuclear disaster, investors will inevitably return to the question of whether insurers will sell Treasury holdings to finance rebuilding.

If they do, some traders expect the government to act through the Bank of Japan to fight the rise in the yen, which could ultimately lead to more foreign buying of Treasuries.

“I think it is positive for Treasuries. The BOJ will not sell Treasuries. That would cause the yen to appreciate,” said Thomas di Galoma, senior managing director at Guggenheim Securities in New York.

“The BOJ is more likely to buy Treasuries to drive the exchange value of the yen down to stimulate the economy and help exports.”

Christian Cooper, head of U.S. dollar derivatives trading at Jefferies & Co in New York, said he expected any Japan-related sell-off to be limited.

“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,” Cooper said.

“They will need massive liquidity but won’t be forced to sell assets to get it. If anything, I expect slight buying pressure as the market begins to add this to the growing list of items that could reduce growth: Middle East unrest and further periphery deterioration in Europe.”

Editing by Dale Hudson

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