Japanese stocks fell 7.6%, on track for the biggest daily loss since October 2008, and bond yields rose on Monday as investors expected the earthquake and tsunami that devastated the country's northeast to take an economic toll and require heavy government borrowing.
The drop in Tokyo-listed shares was compounded by fears about the longer term impact on power supplies after the earthquake damaged a nuclear generator and authorities worked desperately to avert a plant meltdown after an explosion on Monday.
The yen also slid against the dollar after hedge funds unloaded the Japanese currency after the Bank of Japan announced a total of 15 trillion yen in fund injections to keep money markets stable.
The Japanese government bond yield curve steepened, with super-long debt retreating as market players anticipated the potential fiscal costs of future rebuilding efforts, even as short- to medium-term JGBs rallied.
Japanese automakers and, electronics firms and oil refiners saw their share prices drop by double digit percentages after having to shutter key factories after Friday's earthquake and tsunami, which are feared to have killed more than 10,000 people and severely damage infrastructure.
"Investors are selling aggressively as they want to remove risks. The market will sell until they have completed their selling needs, but I really can't tell the extent of a possible sales as this is not the normal market condition," said Hiroshi Arano, advisor at Mizuho Asset Management in Tokyo.
"The market will be very cautious about buying Japanese shares even though the value of Japanese shares are attractive after falls. The market will see the condition of the actual state of the Japanese economy over the next two to three months, before making any concrete decision," Arano said.
Construction firms in demand, technology dumped
The benchmark Nikkei index fell 6.2 percent to 9,618.84, and slumped to a four-month intraday low at one point, with technology companies such as Kyocera Corp and Canon Inc the biggest drags on the market. Japan's Nikkei stock futures fell 6.2 percent <0#JNI:> compared to the regular session close on Friday, and last stood at 9,530.
The broader TOPIX index was down 7.6% at 845.90, on course for the largest daily decline since October 2008 in the wake of the Lehman Brothers failure.
"Domestic investment trusts and funds are dumping everything today. Sell orders for tens of billions of yen were detected," said an equities trader at a Japanese domestic institutional investor, who declined to be quoted by name.
"Foreigners, long-term European pension funds so far are on the sidelines, they're not behind this sell-off," the trader added.
Shares of Tokyo Electric Power , Japan's biggest utility that owns a nuclear plant in the northeast that may be close to meltdown, were a big focus for the market. The stock was untraded on a glut of sell orders and was last quoted at 1,621 yen, down about 24 percent from Friday's close.
Tokyo Electric has battled to cool damaged reactors at its Fukushima plant damaged by the quake and subsequent tsunami on Friday, forcing it to vent radioactive gas to relieve pressure inside the reactors. The Fukushima plant was rocked by a hydrogen blast on Monday, and officials were not able immediately to confirm if any radioactivity was leaked.
"It will be very difficult for Japan to stop its reliance on nuclear energy, and such energy is necessary for stable economic growth of the country, so if the post-incident inspection is negative, it will impact economy in the long run," Shinichi Ichikawa, chief market strategist for Credit Suisse in Tokyo.
Construction-related businesses rallied on the back of expectations for demand from rebuilding efforts, with Kajima Corp jumping 22 percent to 278 yen and Taiheiyo Cement climbing 27.4 percent to 144 yen .
In the month after the earthquake in Kobe in January 1995, construction stocks outperformed the broader market consistently for a year after the disaster, Citi research showed.
In the bond market, the five-year/20-year JGB yield spread widened by 11.5 basis points to a three-month high of 159.5 basis points , indicating investors were selling longer-term maturities.
Super-long JGBs, 20 to 30-year bonds, were hit by concerns about the fiscal impact from the damages caused by the earthquake and as market players braced for the possibility that Japanese life insurers may sell the segment of the yield curve to fund payments to policy holders.
Underscoring concerns about Japan's fiscal health, Japanese sovereign credit default swaps stood at 91 basis points, about 10 basis points wider on the day and near the peaks close to 100 basis points reached last year during the euro zone crisis.
Moody's Investors Service told Reuters the economic impact from the earthquake and tsunami was worse than initially expected, adding that Japan's target of issuing 44 trillion yen in JGBs this year would most likely be overshot because of financing needed for reconstruction.
Short-term to 10-year JGBs rallied, supported by the BOJ's decision to supply ample liquidity to the money market.
The yen rallied broadly in early Asia but quickly pared gains in volatile trade as nervous traders waited to see what action Japanese officials will take to keep markets calm after Friday's quake and tsunami.
The dollar initially extended its losses after having slid more than one percent against the yen on Friday, touching a four-month low around 80.60 yen . The dollar later rebounded sharply in thin trade and last stood at 82.08 yen, up 0.4% on the day.
The Bank of Japan, which holds a policy meeting on Monday, injected 7 trillion yen into the money market via a same-day operation. It later injected an additional 5 trillion yen in same-day funds and a BOJ official said the central bank will closely monitor the currency market in deciding the need for further market operations.