Caught Between Scylla and Charybdis

The Challenge for Monetary Policy in 2024, and How to Front Run It

In Greek mythology, Scylla and Charybdis are sea monsters that challenge characters such as Odysseus, Jason, and Aeneas. 

It’s also a stanza from the song, “Wrapped Around Your Finger” by The Police.

In modern syntax, being between the Scylla and Charybdis refers to being between two difficult, if not impossible, situations. 

The proverbial rock and the hard place.

In 2024, the Fed will need to navigate between the Scylla of strong H1 growth and the Charybdis of a growing disinflationary impulse.

The real growth impulse of H2 2023 can in large part be explained by the decline in inflation during the same period.

• Mechanically speaking, as inflation declines, real economic growth takes up a larger portion of the nominal GDP framework.

• As disinflation accelerated and got underway by June 2023, Q3 delivered a whopper of real growth, and the projected real Q4 GDP of 2.7% is solidly above the long term trend of 1.8%.

By last week, disinflation had become the pink elephant in the room that could no longer be ignored, and the Fed pivoted and signaled the start of a policy rate cutting cycle for next year.

It does not take a leap of imagination to spot to the contradictions embedded in this policy change.

• Policy rate cuts in the context of a solid growth environment is an unorthodox policy pivot, as the Fed has typically waited for labor market or output weakness before cuts.

• Economic growth is still strong, even after a decline from Q3’s torrid growth pace.

• The labor market remains secularly tight, with unemployment ticking down by 20bps in November to 3.7% from 3.9%.

• Signaling policy rate cuts is stimulatory to an already warm/hottish economy.

• Falling inflation is itself stimulatory, as it increases the real spending power of consumers, potentially overheating the economy’s capacity to deliver goods and services without an additional inflationary impulse.

On the surface, none of this is wrong.  None of it is historically inconsistent.

However, it lacks strategic focus and represents lazy first order thinking.