Long Time Devotee May Amp Up Bond Buys

U.S. Treasury bonds are losing favor amid the impasse on the deficit reduction, but there's one country that still has strong reason to buy up American debt. Hint -- it's not China. It's our second largest foreign creditor -- Japan.

With the yen at an all-time high against the greenback, Japan's government will likely want to keep appreciation at bay. It's likely to convert excess currency into the U.S. dollar then soak up U.S. government bonds, still considered the asset lowest in risk worldwide.

Given Japan's past practices, fixed income strategists are predicting that the government might try to talk down the yen soon and undertake a currency intervention in the coming weeks.

Finance Minister Yoshihiko Noda has already hinted that the central bank might take action. Earlier this week, Noda called recent gains in the yen "one-sided" due to "overseas" factors. "I will watch the market carefully and respond," he said.

Adding to the intrigue is the gridlock in Washington. If a downgrade of U.S. credit does occur, yields will like rise, weakening the dollar.

"Since a dollar sell-off would cause a sharp appreciation in the yen, Japan could try to act earlier," says Jeffrey Bergstrand, international trade professor at the University of Notre Dame.

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