2016 Q1 House Views Update
by Nikko Asset Management's Global Investment Committee

Introduction

Nikko Asset Management's Global Investment Committee met on March 29th and updated our intermediate-term house view on the global economic backdrop, central bank policies, financial markets and investment strategy advice.

We expect June and December Fed hikes, but only mild further easing ahead for the BOJ and ECB. Meanwhile, we expect oil prices to creep higher through 2016 despite the stronger USD due to relatively firm economic developments in China and the G-3.

We expect that global equity and bond investing will be positive for Yen based investors due to Yen weakness, but for USD based investors, we are taking only a neutral stance on global equities due to a cautious forecast for US equities, whereas we are positive on Asia-Pac ex Japan, Japan and Europe. Meanwhile, we are moderately negative on bonds in each region when measured in USD terms, so we underweight them.

Fed in June and December, but ECB or BOJ Slight Easing

We were too hawkish in early December for expecting one Fed hike per quarter, but it still is a possibility to have quarterly hikes after March. Market consensus is for only one hike this year (with a slight chance of two hikes like the Fed’s dot plot indicates), but we think hikes in June and December are likely. There is a chance that the June hike could be delayed until July if the Fed wishes to wait for the Brexit vote. If delayed, there will likely be several hawkish dissents at the June meeting as well as the April meeting (and in speeches before such), which may stir market concerns about a divided Fed even further.

Core US CPI inflation should remain firm at 2.3% YoY through September as medical prices continue to rebound and shelter costs remain high. As a side note, we use the CPI for inflation forecasting because the PCE deflator is often heavily revised, which has been a source of great chagrin by Fed officials in the past, whereas the CPI is never significantly revised. However, it is worth noting that core PCE inflation has accelerated and will likely stay at 1.7% YoY (near the Fed’s 2% goal) as its growth moderates to a 0.15% MoM basis.

In Japan, the BOJ surprised us (and most everyone else) with its move to negative rates on “excessive” reserves. We had stated that an ease was possible if the Yen hit 110-115, but the BOJ moved at 118. Its move was partly due to fears of the effects of an even stronger Yen, but after initially weakening, the Yen abruptly strengthened as traders seemed to think that doubts about BOJ policy stability (and global economic woes) would cause Japanese repatriation flows. This still seems illogical to us and will likely reverse. The economy in the 1Q should be fairly weak, so there is some justification to ease policy a bit further, but further rate cuts seems unlikely due to the previous bad reaction in Japanese banks’ equity prices. Although the official Core CPI, which includes energy, is very low, excluding food and energy, it is 0.7% YoY and will likely accelerate above 1.0% in the quarters ahead. Notably, housing rent is a significant part of core inflation and it continues to be soft, but it should start rising. Indeed, unless rent starts to rise, it will be very difficult to ever hit the core target on a structural basis. Also, it is likely that the 2% target was made for psychological effect (to boost reflationary behaviour) and that the BOJ is secretly happy with 1.5%, which, to be honest, has long-seemed a more appropriate target to us.

In December, we expected ECB easing but it was much more aggressive than expected, shifting to a heavy intervention in private-sector bonds. Germany and a few others were opposed to the measures. The EUR weakened on the news until Draghi hinted in the press conference that they might not ease aggressively further, which then caused a sharp strengthening in the currency. We, thus, expect some mild further easing ahead (not including a rate cut), but it is a close call. Furthermore, while consumer inflation will remain low YoY in the coming months due to lower oil prices, core inflation will likely rise from 0.8% YoY currently to 1.1% to 1.2% by mid-2016 due to increased economic growth and increased residential rents.

As for the BoE, Brexit concerns will likely linger even after a vote to remain, so we do not expect a 25 bps rate hike until 1Q17.

Meanwhile in China, we expect the PBOC to reduce interest rates and/or the reserve ratio requirement a bit further in the coming quarters.

As for geopolitics, clearly the increase in ISIS related terrorist attacks in the West are a larger risk factor now. Attacks in MENA are also quite possible too. Worries about such will rise and fall, but the overall intermediate-term effect should be minor. 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. It is also possible that fears of Trump upsetting the world order could cause market, political and economic jitters.

As for oil, signs of cooperation between Russia and OPEC on freezing production, along with declining US production and the reduced fears of a global economic recession led to higher oil prices despite very high global oil inventories and Iran’s new exports. We expect Brent oil to be $45 at end September and to increase very slightly in the following quarters. Credit stress is rising rapidly in the US shale sector, with quite a few major companies going bankrupt and methods to maximize short-term production (as the cost of inefficient depletion) seem be faltering, so we still think US production will likely decline more rapidly than expected. On the other hand, Iran will export even more oil, which should cap prices. As for other commodity prices, despite a stronger USD, they will likely stabilize or rise a bit further due to continued global economic growth.