The Fed's Policy Dilemma: Inflation Easing or Data Anomalies?

The Federal Reserve faces a critical juncture as it grapples with conflicting signals from the November 2025 inflation report. The Consumer Price Index (CPI) showed a year-over-year increase of 2.7%, below the 3.1% forecast, marking a slowdown from September's 3.0% rise. Core CPI, which excludes volatile food and energy, rose 2.6% annually-the lowest increase since March 2021. While these figures suggest easing inflationary pressures, the reliability of the data is clouded by methodological distortions caused by a 43-day government shutdown that disrupted October data collection according to BLS data. This raises a pivotal question: Is the reported moderation in inflation genuine, or is it an artifact of incomplete data? The answer will shape the Fed's policy trajectory and influence risk asset performance in 2026.

The November CPI: A Mixed Signal Amid Data Gaps

The November CPI report, the first since the government shutdown, omitted month-over-month changes and relied on imputed data for October, which could introduce downward bias. For instance, the energy index rose 4.2% annually, driven by an 11.3% surge in fuel oil prices, while food prices climbed 2.6%, led by a 4.7% increase in meats, poultry, and eggs. These sector-specific trends highlight persistent inflationary pressures, yet the overall annual rate appears to have softened.

However, economists caution that the data is "noisy and full of gaps" according to market analysis. The Bureau of Labor Statistics (BLS) itself emphasized that the annual figures should be interpreted with caution, as the shutdown prevented retroactive data collection for October. Goldman Sachs Asset Management noted that the Fed will likely rely on the December CPI report, expected in January 2026, to discern a clearer trend. This uncertainty complicates the Fed's ability to assess whether inflation is genuinely trending toward its 2% target or if the November reading is a statistical anomaly.

The Fed's Dual Lens: Core PCE vs. CPI

The Federal Reserve's policy decisions hinge on the core Personal Consumption Expenditures (PCE) index, its preferred inflation metric. In September 2025, core PCE showed a 2.8% annual increase, slightly below expectations, aligning with the CPI's moderation. However, alternative forecasting models indicate that core inflation remained elevated at 3.0% year-over-year during the shutdown period. Fed officials, including Atlanta Fed President Raphael Bostic, acknowledged the challenge of formulating policy with incomplete data but emphasized that price stability remained the "clearer and more urgent risk".

The December 2025 rate cut-25 basis points, bringing the target policy rate to 3.50%-3.75%-reflects a measured response to a cooling labor market and persistent inflationary pressures. While the move aligns with market expectations, it underscores the Fed's data-dependent approach. Governor Miran highlighted that nonmarket-based components of core services inflation, such as portfolio management fees, can distort the true inflation picture, advocating for a focus on market-based services where inflation has already moderated. This nuanced analysis suggests the Fed is cautiously navigating a landscape where CPI and PCE data may diverge in their policy implications.

Market Implications: Rate Cuts and Risk Asset Rally

The Fed's December rate cut, though anticipated, has already triggered a rally in risk assets. Treasury prices surged, and equity markets gained momentum as investors interpreted the CPI data as a sign of continued disinflation. However, the broader economic outlook remains clouded by uncertainties around the inflationary impact of tariffs and the reliability of future data releases.

Analysts at RBC note that the Fed has reached a "neutral policy stance," with the federal funds rate now within a broad estimate of its neutral value. The median forecast in the SEP suggests only one additional 25-basis-point cut in 2026. This cautious outlook is tempered by the risk of elevated inflation from tariffs, which continue to place upward pressure on prices, albeit less severely than initially feared. For investors, the key takeaway is that while rate cuts are likely, their effectiveness may be limited, particularly for low-income consumers already constrained by debt and spending habits.

Conclusion: A Delicate Balancing Act

The November CPI report presents a paradox: a statistically significant moderation in inflation, yet a methodologically compromised dataset. The Fed's reliance on core PCE and alternative indicators suggests it is cautiously optimistic about disinflationary trends, but the December rate cut reflects a hedging strategy against persistent risks. For markets, the immediate outlook is one of relief, but the path forward remains contingent on the January 2026 CPI report and the Fed's ability to disentangle genuine inflationary cooling from data anomalies. Investors must remain vigilant, balancing optimism about rate cuts with caution regarding the durability of the current disinflationary narrative.