Headwinds in the third quarter

Headwinds in the third quarter

In the third quarter, we believe the global economy will face three risk factors: economic slowdown, with inflation and interest rates remaining high; risks from tighter financial liquidity; and slower economic growth in China and emerging markets.

In the United States, the Conference Board leading economic indicators have fallen for a 13th consecutive month, while retail sales are slowing. Private investment, measured by orders for durable goods, has also slowed sharply. Consumer price inflation, at 4.0% in May, is down from 9.1% in June 2022 but still relatively high, pressuring the Federal Reserve to signal more interest-rate increases.

Further tightening bias, coupled with tightening US fiscal policy, could further squeeze liquidity. The banking crisis in March caused regional banks to tighten lending, slowing credit growth while deposits have also contracted more heavily.

The implication of the US debt ceiling extension in early June is that the US Treasury can issue around $1 trillion in bonds in the next three months to replenish its holdings, currently around $71 billion. That is roughly $300 billion per month, around three times the Fed's quantitative tightening of around $95 billion a month. Such measures will drain more liquidity from the system.

As a result, US Treasury yields, both short- and long-term, have bounced around 50 basis points since the debt ceiling debate in May, and are still elevated.

The cumulative effect of all these factors will be a further tightening of US money supply, already on course to contract by 4.7% this year, the deepest since the 1950s.

With the services sector and the labour market still strong amid the gradual reduction in inflation, we expect the Fed to keep interest rates high until the fourth quarter. But high rates at a time of a gradual fall in inflation will turn the real policy rate positive, pressuring the economy in the future.


In China, meanwhile, the economy has been growing much lower than expected. Many private-sector economists fear a double-dip recession, with economic figures in May showing lower-than-expected growth in all indices. Exports contracted sharply, while a producer price contraction indicates a risk of deflation.

This has led the People's Bank of China to cut its policy interest rates, while massive fiscal stimulus is also a possibility. Analysts believe the central government might issue anywhere between 500 billion and 1 trillion yuan in special purpose bonds to stimulate the economy.

However, we believe China's fiscal stimulus will be limited as the national debt is already too high, at 297% of GDP. As well, local governments are unwilling to disburse large stimulus funds given strict central government rules to curb corruption. Local government revenue from land sales to developers has also fallen due to the real estate contraction. Hence, local authorities have less money to meet their interest burden.

All told, China's economic slowdown combined with tighter global liquidity will make the global economy riskier going forward.


Turning to the Thai economy, we see four primary risks:

First, the export slowdown: Exports of key industrial products to major economies continue to contract, reflecting the slowing global economy. High inventory levels and global economic deterioration will continue to pressure demand for Thai export goods.

Second, the prolonged political vacuum: The longer it takes to form the new government, the longer the delay in passing the new budget for the 2024 fiscal year that starts on Oct 1. This will delay disbursement by up to two or three quarters, which in turn means public consumption and public investment will contract more strongly in the second half of this year.

In every year in which there was a change in government, budget disbursement and private investment have been affected. Consequently, we have downgraded our 2023 public consumption and investment forecasts to contractions of 2.7% and 0.1%, from previous projections of 0.9% and 3.0% growth, respectively.

Third, contractionary monetary policy despite continued declines in inflation. Inflation in May 2023 continued to decline, but The Bank of Thailand is "leaving the door open" to raising rates further. We believe the central bank will likely keep its benchmark rate at 2%, which would turn the real policy rate positive in the second half of the year, a negative for the economy.

We expect the business sector to be heavily affected by interest rate increases. The policy rate has risen by 150 basis points since tightening began last year, pushing minimum lending rates up 160 basis points. Higher interest rates have led to a clear slowdown in loan growth, from 8.9% per year in October 2021 to 2.3% in March 2023.

Loan shrinkage has a significant impact on investment. In March, investment contracted 0.3% year-on-year. Looking forward, tightening monetary conditions will cause commercial bank interest rates to increase. Private investment is likely to shrink further.

Finally, a possible drought from El Niño. If the Southern Oscillation Index goes into negative territory in the third quarter and drags on into the fourth quarter, it could lead to an El Nino in late 2023 and early 2024, which could lead to a severe contraction of agricultural production, as was seen in 2015-17. The crops most vulnerable to drought are cereals, particularly rice and maize.

As a result, we have revised down our economic forecast for Thailand this year from 3.0% growth to 2.7%, with a sharp reduction in consumption and government investment, as well as in private investment and consumption. Exports will contract in response to a worsening global economy. Inflation will decline sharply due to a slowdown in both domestic and international economies.

In terms of investment implications, InnovestX Research maintains a defensive and selective strategy. We recommend stocks that face relatively limited impact from political uncertainty, with strong earnings and profit resiliency when faced with global and domestic economic downturns. Our picks for the third quarter are BBL, BDMS, BEM, HMPRO and OSP.

Dr Piyasak Manason is Senior Director of the Investment Research Department at InnovestX Securities Co Ltd

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