2015 Q2 House Views Update
by Nikko Asset Management's Global Investment Committee

Although we expected G-3 bond yields to rise, they did so more than we predicted in our March meeting, mostly due to the end of deflationary fears in Europe and a rebound in US economic prospects. We expect yields to rise moderately further for the next two quarters. For US 10Y Treasuries, our target for September-end is 2.50%, while those for 10Y JGBs and German Bunds are 0.50% and 0.90%, respectively. For Australia we expect a rise to 3.1%. Our targets for year-end are 2.65%, 0.6%, 1.0% and 3.2% respectively. This implies (coupled with our forex targets), that including coupon income, the Citigroup WGBI (index of global bonds) should produce a -3.6% return from our base date of June 19th through December in USD terms. Thus, we remain negative on global bonds for USD based investors. This index should perform a bit better, at -0.3% in Yen terms due to expected Yen weakness (see below). As for JGBS, we target the 10Y to have a -1.3% return in Yen terms through December, and prefer ex-Japan bonds for Japanese investors, although those too are targeted to have slightly negative returns in Yen terms.

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 September will finish at 125: USD, with 127 at December-end. Elsewhere in the Asia Pacific region, we expect the CNY to be flat vs. the USD at end-December and for the AUD to weaken to 0.75 vs. the USD by then due to the general, but moderate, strength in the USD.

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-September and 1.07 at December-end. As mentioned above, we expect ECB rhetoric to be much less dovish soon, which, together with rising inflation and economic prospects, will help prevent the EUR from falling too sharply vs. the USD.

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 become a stalemate, as neither side can control its rival's areas. 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 Iran, we expect a deal to be completed. This will increase fears of oil oversupply, so despite Saudi efforts to support prices, we expect Brent oil to fall to $61 at end December and remain low thereafter. Frankly, we have been surprised that oil prices did not fall last quarter despite a massive increase in global inventories. It seems that speculators in oil were willing to store it in the hopes that a Middle East crisis would occur.

Looking ahead, we would predict a more major decline if the G-3 and China's economies weren't recovering so well. Despite good global economic growth, other commodity prices will likely remain quite flat in our view, partially due to a stronger USD.