Daily Commentary BY THE CURVE TEAM –

CAPEX Collapses as Fed Moves the Goal Posts

28th of August, 2020

Capex in Australia capitulated in Q2 with worse to come while the Fed Chairman announced new mandate targets overnight.

Despite beating expectations of an awful 8.2% decline in Capex, the 5.9% fall for the quarter was still significant. Forward looking expectations for Capex were down with the 3rd estimate for the next financial year falling 12.6% from the 3rd estimate last year.

The fall in construction work done and CAPEX amounts to a 0.4% point fall in GDP for Q2. On the upside, this is better than anticipated, suggesting Q2 GDP may hold up a little better than initially feared.

Overseas, the Federal Reserve officially changed its policy targets on inflation and employment. Rather than targeting inflation of 2% constantly, they will now target 2% on average.

The shift has been touted for some time and means the Fed would allow the economy to have periods of inflation above 2% to offset periods below 2%. Which in effect means the Fed can let the economy run hot for longer, whereas previously their policy would have tried to reign in inflation as soon as it went above 2%.

The Fed also changed how employment levels would inform their decisions, which similar to the inflation averaging will allow the economy to run hotter for longer. The Fed will now address shortfalls in employment rather than ‘deviations’ from the estimated maximum level.

This reflects that recent estimates of the non-accelerating inflation rate of unemployment (NAIRU)- the unemployment rate at which inflation picks up which relates to the Phillip’s Curve- has underestimated the full employment rate of the economy. The change to fill shortfalls will allow the Fed to continue with accommodating monetary policy if inflation and unemployment are both low.

Both the change in approach to inflation and employment will give scope for more expansive monetary policy than previous targets would have warranted. Although even as the Fed balance sheet rises to record levels, the Fed has not been able to sustain inflation at its 2% target. So it remains to be seen whether more accommodating monetary policy is the solution to inflation being below the target.

Josh Stewart

Client Relationship Manager