March 16th, 2011
03:04 AM GMT
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(CNN) – Japan's benchmark Nikkei 225 index rallied some 5% in the first 15 minutes of trade on Wednesday, bouncing off a 10.5% loss in previous session.  Market watchers however warn that the worst may not yet be over given the various challenges Japan faces after the strongest Earthquake ever to hit the country.

"We're hostage to the next headline,” said Richard Yetsenga, HSBC's Asia currency strategist.

Tuesday’s sell off – lead by foreign investors dumping Japanese equities, market watchers say – was described as a panic reaction to the escalating crisis in Japan and the fear problems at the Fukushima Daiichi Nuclear Plant could impact human health and extend evacuation.

Right now, equity players are watching currency players and vice versa.  The Bank of Japan, in effort to shore up confidence in the Japanese economy, has injected large amounts of cash into the system to keep money moving and make it easy for the economy to function.

In the first hour of trade on Wednesday the central bank injected another $43.2 billion or 3.5 trillion yen into the system. That raises the total of same day cash Tokyo has injected to support its economy to $325 billion in the past three days.

There's talk the BOJ is prepared to do whatever it takes to stabilize the currency – indeed, we saw a weakening of the Yen within minutes of the central bank's move and the opening of the Tokyo trading day.

Stability is key for investor confidence, analysts say, and the BOJ and government moves are a positive signal.  That said, measures of volatility have jumped – the VIX, the so-called ‘fear index,’ jumped 15% during Tuesday’s trade. That's a sign that there are still many unknowns.

There is a huge relief effort already taking place but rolling black outs could impact on productivity in the medium term.  One note from BNP Paribas notes the rolling blackouts by Tokyo Electric Power (the company that runs the Fukashima Daiichi plant) will affect nine prefectures of the north, including Tokyo.  These nine prefectures account for about 40% of Japan's GDP.

So as the drama unfolds, the potential economic impact of the disaster remains unknown.

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