2015 Q3 House Views Update
by Nikko Asset Management's Global Investment Committee

Although we expected G-3 bond yields to rise, they did so less than we predicted in our June meeting. We expect yields to rise moderately further for the next two quarters. For US 10Y Treasuries, our target for December-end is 2.35%, while those for 10Y JGBs and German Bunds are 0.45% and 0.8%, respectively. For Australia we expect a rise to 2.9%. Our targets for March-end are 2.50%, 0.65%, 0.9% and 3.0% respectively. This implies (coupled with our forex targets) that including coupon income, the Citigroup WGBI (index of global bonds) should produce a -2.0% return from our base date of Sept 11th through December in USD terms and -3.3% by end March. Thus, we remain negative on global bonds for USD based investors. This index should perform a bit better, at 0.0% and -0.5%, respectively, in Yen terms due to expected Yen weakness (see below). As for JGBs, we target the 10Y to have a -0.8% return in Yen terms through December and -1.6% at end March, and prefer ex-Japan bonds for Japanese investors, although those too are targeted to have slightly negative returns in Yen terms through March.

Thanks to Japan’s large monetary easing stance vs. a Fed normalization policy, coupled with a negative trade balance and higher interest rates abroad, we continue to expect the Yen to weaken in the quarters ahead. We now forecast that December will finish at 123: USD, with 124 at March-end. We expect the AUD to weaken to 0.70 vs. the USD by March due to the general, but moderate, strength in the USD and the mild decline in commodity prices. As for the EUR, the ECB’s aggressive QE program will likely overshadow the region’s continually high current account surpluses, and push the currency moderately lower. Our estimates are 1.10: USD at end-December and 1.08 at end-March.

As for geopolitics, we still foresee Ukraine as a stalemate, with neither side wishing to be overly-aggressive. We don’t expect sanctions or reprisals to deeply affect the global economy, but relations will be testy and Russia has been greatly lost to the G-3. We also expect Iraq to remain a stalemate, as neither side can control its rival’s areas. The US and Russia now seem to be cooperating to prevent ISIS from controlling Syria, but there is always some chance of miscalculation. Other risks (including China’s aggressive territorial claims, North Korea, other MENA unrest, EM political strife, etc...) will likely occasionally instill fears in risk markets, but not likely lead to crisis.

As for oil, Iran is already disgorging its large storage of condensates and its future oil exports will continue to instill fears of oil oversupply (including the overproduction of many other OPEC countries), along with very high global oil inventories. US production is finally declining, but we still expect Brent oil to fall to $47 at end December and remain low thereafter. In June we mentioned that we were very surprised by the rally in oil prices, as inventories remained high, and we predicted it to decline from $63, but it fell much more than we expected. There is a chance that the Saudis, fearing excess fiscal deficits, will “declare victory” over the US shale industry and start to make positive comments about oil prices, but there does not seem to be any sign of such and no analysts seem to be predicting it either. As for other commodity prices, they will likely decline a bit further, partially due to a stronger USD.