On the oil front, it looks like prices will go down because Japan will not be using as much oil in the near term. The economy there is understandably grinding to a halt. Rescue operations and humanitarian missions are in full swing. Humanitarian needs of millions of people will continue for weeks and even months. When things do settle down, construction companies will get work rebuilding Japan, but rebuilding is not the same as business expansion. Rebuilding is just getting things back to where they were before the quake, but regardless, Japan will rebuild its cities, roads, refineries, rail system and infrastructure. That will take money–and lots of it.
One way for Japan to get money is to sell some of its $882 billion in Treasury bonds, and that is just what happened last Friday. The Wall Street Journal reported, “. . . Japanese investors sold U.S. government bonds to repatriate money home following the earthquake that hit that country. . . . Long-dated Treasurys were the biggest losers, reflecting concern that Japanese insurers may continue to sell such securities to pay insurance claims in the coming sessions. Such selling, however, was partly offset by buying from some investors seeking safety from the political turmoil in the Middle East and the euro-zone’s sovereign-debt woes.” (Click here to read the complete WSJ story.)
Japan is the second largest holder of U.S. debt. If Japan keeps selling, expect QE3 to begin sooner than expected. Other countries holding U.S. Treasuries may also sell if they fear an all-out U.S. bond rout. That could send interest rates up and mortgage rates would follow. There is another view reported by Reuters Friday, “The BOJ (Bank of Japan)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. (Click here for the complete Reuters story.)
Even if Japan doesn’t sell a large chunk of Treasuries, it certainly will not be buying any in the future. Knock out the number two largest buyer of U.S. debt, and that will surely put upward pressure on interest rates. The Fed desperately wants interest rates to stay low so the U.S. economy will not jump off the tracks and plunge into depression. If rates do rise, expect the Fed to turn up the printing presses to hold rates down and fuel more inflation. This problem seems small compared to what the Japanese people are dealing with now. Please pray for Japan.
