Fed Policy in a Data Void: Implications for Rate Cuts and Inflation Signals in 2026

The U.S. Federal Reserve now faces a paradox: a cooling inflation narrative juxtaposed with a data void. The November 2025 Consumer Price Index (CPI) report, released on December 18, 2025, showed a year-over-year inflation rate of 2.7%, a decline from September's 3.0% and below economists' forecasts of 3.1%. However, this reading was shaped by a government shutdown that disrupted data collection for October and November, forcing the Bureau of Labor Statistics to rely on imputations and historical norms. The resulting uncertainty has left policymakers and investors grappling with a critical question: Is this a genuine sign of progress toward the Fed's 2% inflation target, or a statistical artifact of methodological constraints?

The Data Void and Its Consequences

The October 2025 government shutdown, which lasted 42 days, crippled the BLS's ability to collect price data. October's CPI was canceled entirely, and November's data collection began on November 14-17 days later than usual-due to delayed reopenings. To fill the gap, the BLS carried forward October prices from September and used imputations for 40% of September's data, a record high. This approach, while necessary, introduced distortions. For example, shelter costs-a 43% weight in the CPI-were effectively frozen at September levels, masking potential price changes. Similarly, seasonal adjustments were compromised, as the truncated data collection period overlapped with Thanksgiving holiday sales.

Economists have warned that these methodological shifts likely biased the November CPI downward. As noted by Morningstar's analysis, the report "reflects assumptions used by the BLS and could be biased downward." The absence of month-over-month comparisons further complicates trend analysis, leaving the Fed with a fragmented view of inflation dynamics.

Fed Policy in a Fog of Uncertainty

Despite these challenges, the Federal Reserve has already acted. In December 2025, the Fed cut the federal funds rate by 25 basis points, its third reduction since September. This move was driven by a dual mandate dilemma: while inflation remains above 2%, the labor market has softened, with unemployment rising to 4.6% in November. The Fed's cautious stance is evident in its emphasis on "further data" to guide future decisions, particularly the December CPI report, which will be critical in shaping 2026 policy.

Market expectations for rate cuts in 2026 have surged. As of early December 2025, the probability of a January 2026 rate cut stood at 26.6%, with some analysts projecting two cuts in Q1 2026. However, the Fed's reliance on the December CPI-potentially another distorted report-introduces volatility into these expectations. If the December data shows further easing, the Fed may accelerate cuts; if it reveals persistent inflationary pressures, the central bank could pause. This uncertainty has created a tug-of-war between inflation hawks and doves, with the former warning that the 2% target remains distant.

Investment Implications: Navigating the Fog

The distorted CPI data and Fed uncertainty have significant implications for asset classes:

Equities: U.S. equities enter 2026 with valuations near historical highs, driven by a technology-led rally. However, the K-shaped recovery-where wealthier individuals and large corporations outperform-suggests caution. Value stocks, which have lagged in recent years, may offer mean reversion opportunities as rate cuts broaden economic growth. Emerging markets could also benefit from accommodative Fed policy, provided they maintain strong monetary frameworks.

Fixed Income: The Fed's rate-cutting trajectory and declining interest rates make high-quality bonds increasingly attractive. Short- to intermediate-term bonds (2–5 years) are particularly compelling, as they offer a balance between yield preservation and capital appreciation. Pimco highlights that bond ladders and diversified short-duration strategies can hedge against rate volatility while capturing income.

Commodities: Gold's role as an inflation hedge remains robust, especially as central banks diversify reserves. Meanwhile, industrial metals like copper and lithium could see demand surges from AI-driven infrastructure spending. However, the Fed's focus on inflation may temper commodity gains unless rate cuts accelerate.

Conclusion: A Delicate Balancing Act

The November 2025 CPI data, while suggesting a cooling inflation trend, is best interpreted with skepticism. The government shutdown's methodological distortions-particularly the imputation of missing October data-likely exaggerated the downward bias in the report. For the Fed, this creates a dilemma: cutting rates too aggressively risks reigniting inflation, while delaying action could stoke recessionary fears. Investors, meanwhile, must navigate a landscape where policy decisions are increasingly influenced by incomplete data.

As 2026 unfolds, the December CPI and subsequent reports will be pivotal. Until then, a diversified, defensive strategy-prioritizing high-quality bonds, value equities, and inflation-linked assets-may offer the best protection against the Fed's next moves in a data-void environment.