In like a lion and out like a lamb may reflect the typical weather patterns in March. But it most certainly does not describe the foreign-exchange market.

The yen began the month with a surge and finished the month with a surge of a similar magnitude. It soared to new record highs against the beleaguered euro and recouped nearly everything it lost against the dollar in January and February.

Japan is about to start its new fiscal year, and where the country (which has about a third of the world's savings) invests may ripple through the global capital markets. Let's begin with an overview of the policy-making environment in Japan, then turn our attention to the likely capital flows.

After contracting in the second half of last year, the Japanese economy appears to have resumed its recovery so far this year. Capital expenditures seem to have bottomed, and production has been boosted. The trade surplus has begun expanding again. Domestic consumption is mixed, with some signs that the pace of contraction is slowing. Deflationary pressures still are evident, despite the sharp rise in oil prices. Consumer prices remain below year-ago levels.

Fiscal policy is expansionary, and a supplemental budget in early fall cannot be ruled out at this point. The

Bank of Japan's

near-zero interest-rate policy is set to continue, but policymakers have begun suggesting that its days are numbered. One line of speculation is that the Obuchi government would like a rate increase before it schedules an election for the lower house of the


, so as to enhance its appeal to pensioners who have been hurt by the low interest rates. The election must be held by the end of October.

At the same time, the


economic summit will be held in July in Okinawa. With Japan still under pressure to promote stronger domestic growth, a rise in interest rates prior to the meeting would seem impolitic. The slope of the euro/yen futures strip (three-month deposit contracts like eurodollars) suggests that the market perceives a slightly greater chance of a rate hike in the fourth quarter, rather than in the second or third.

Typically, Japanese institutional investors step up their purchase of foreign assets at the beginning of the new fiscal year. Some Japanese life insurance companies have already indicated that they will be looking overseas to enhance returns.

The market has been put on notice that there will be a sharp rise in maturities of postal savings vehicles. Official estimates suggest that as much as half of the 106 trillion yen (about $103.5 billion) that matures over the next two fiscal years will leave the system. Some analysts suggest that if as little as 10% of the money that leaves the postal system is moved offshore, the impact could be substantial. Note that last year, Japanese investors bought 8.8 trillion yen in foreign bonds.

Most of the money leaving the postal system is likely to stay in yen-denominated assets. One recent development of note is that corporations and sovereigns have begun issuing euro/yen bonds (yen-denominated bonds issued outside of Japan) and samurai bonds (yen-denominated bonds issued in Japan by non-Japanese entities). There appears to be strong interest from both retail and institutional investors for this typically higher-yielding, yen-denominated paper.

At the same time, Japanese institutions are trying to steer the money freed from the postal savings system into the domestic stock market. A


survey of 10 major Japan-based fund managers and advisers found that the average recommended domestic-equity weighting rose to almost 27.3% from 25.6% in March. Several new Japanese equity trust funds, i.e., mutual funds, were launched over the past week.

Foreign investors also appear to be very keen on Japanese shares.


surveys found that British and European fund managers in particular were bullish, and that is reflected in higher recommended weightings for Japanese stocks. U.S.-based investors did not change their weighting in Japanese shares, according to the



There are two caveats to keep in mind when considering the impact for the portfolio flows on the currency market. First, the foreign-exchange market is massive, and the turnover it experiences in a couple of weeks is more than sufficient to cover all cross-border portfolio transactions in a given year. Indeed, on a month-to-month basis, even if the portfolio flows were known in advance, which they aren't, it still wouldn't be possible to forecast the performance of the yen.

Many observers talk about portfolio flows, and to a lesser extent, direct investment flows, because they can get their hands on the figures. But the bulk of the turnover in the foreign-exchange market is not for these transactions. Most positions in the foreign-exchange market are held for seven days or less. This suggests that one of the key pieces of the foreign-exchange puzzle is the positioning of the banks, not investment flows per se.

The second caveat has to do with how foreigners buy Japanese shares. Essentially, there are two ways. The first, preferred by mutual funds, is simply to go out and buy yen to buy Japanese shares. One would then have exposure to yen and Japanese shares. The second way is to borrow the yen and then buy Japanese shares. Under that strategy, exposure to the yen is neutralized. This strategy was reportedly preferred by some of the leverage fund community, until recently.

My best guess is that the market is set up for buy-the-rumor-sell-the-fact kind of activity after the


survey is released early Monday in Tokyo. The risks of intervention also seem to be increasing, given the spike in volatility. I'd look for the dollar and euro to begin recouping some of the steep losses inflicted against the yen in the coming sessions.



survey of Japanese investment houses found that an average expected range for the dollar in April is 103.70-112.10. Only two houses,

Daiwa Institute of Research


Nikko Asset Management

, forecast a range that would put the dollar below the lows seen before the weekend. The former forecast a dollar low of 102 yen and the latter forecast a dollar low of 100 yen.

Marc Chandler is the chief currency strategist for Mellon Bank. At the time of publication, he held no positions in the currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at