Assessing the Fed's Policy Path Amid Muddled December CPI Data

The Federal Reserve's next moves will hinge on a delicate balancing act: navigating the fog of distorted inflation data while responding to evolving economic signals. The December 2025 Consumer Price Index (CPI) report, released in early January 2026, exemplifies the challenges of policymaking in a world where institutional disruptions-such as the October–November 2025 government shutdown-can warp key economic indicators. For investors, understanding these distortions is critical to anticipating the Fed's trajectory and its implications for asset prices.

The Distortion of Inflation Data

The government shutdown in October and November 2025 disrupted the Bureau of Labor Statistics' (BLS) ability to collect real-time data on inflation. To fill the gap, the BLS resorted to a carry-forward method, imputing November and December data based on prior trends, particularly for categories like rent and services. This approach artificially suppressed November's inflation rate, creating a misleading baseline that exaggerated December's apparent price increases. For instance, goods inflation in December surged due to the normalization of holiday discounts, which had been over-represented in November's distorted data.

The result was a CPI report that painted a sharper inflationary picture than reality. Economists estimate that the annual CPI rate in December 2025 likely hovered around 3%, rather than the 3.7% reported, had October's data been included. This discrepancy underscores the fragility of inflation metrics in the face of institutional dysfunction-a problem that will persist until data collection methods adapt to such shocks.

Implications for Fed Policy

The Federal Reserve, which targets a 2% inflation rate, faces a dilemma. The December CPI report, while distorted, still showed a 0.3% monthly increase, driven by stubbornly high rents and a 0.7% surge in food prices-the largest rise in over three years. These figures, though partially inflated by methodological quirks, reflect genuine pressures in the economy, including supply constraints and tariffs.

Against this backdrop, the Fed is likely to maintain a cautious stance in early 2026. The uncertainty surrounding the data's reliability will temper its willingness to cut rates, even as broader disinflationary trends emerge. According to a report by , many economists expect the Fed to hold interest rates steady in its first two meetings of 2026, prioritizing clarity over action. However, as the year progresses and the distortions fade from memory, the central bank may pivot toward rate cuts if core inflation continues to trend downward.

Investment Considerations

For investors, the key takeaway is that the Fed's policy path will remain contingent on the resolution of two competing forces: the lingering effects of data distortions and the underlying momentum of disinflation. Assets sensitive to rate cuts-such as long-duration equities and high-yield bonds-may find support in the second half of 2026, assuming the Fed deems the inflationary risks sufficiently contained.

Yet, the December CPI also highlights the need for caution. The overstatement of inflation in December, driven by methodological artifacts, serves as a reminder that policy decisions based on flawed data can have unintended consequences. Investors should hedge against both inflationary surprises and the Fed's potential overreaction to them.

Conclusion

The December 2025 CPI report is a cautionary tale of how institutional fragility can complicate monetary policymaking. While the Fed's focus on long-term inflation trends will ultimately prevail, the near-term path remains clouded by the distortions introduced by the government shutdown. For now, the central bank's patience is warranted-but not its complacency. As the data stabilizes, the market will need to recalibrate its expectations for a Fed that may soon find itself with more room to act.