Lower-than-expected inflation: Fed hawks see cracks in their fortress

When Hope Meets Flawed Statistics. The November CPI report surprised markets with numbers that seemed too good to be true: the overall annual rate paused at 2.7% compared to expectations of 3.1%, while core CPI fell to 2.6% against the forecasted 3.0%. It’s no wonder the dollar lost 22 points in a few hours and gold surged upward by $16. But behind this celebration of optimism lurks a hidden danger: the data bears the scars of the October government shutdown.

The Statistically Imperfect Bomb

The Bureau of Labor Statistics faced a thorny problem: due to the October shutdown, data for that month was missing. The solution was to set October’s CPI to zero, a choice that UBS says introduced approximately 27 basis points of uncertainty into the final figure. In other words, actual inflation could be closer to 3.0%, the level the market was already expecting.

Yet, beyond the statistical “noise,” there are genuine signs of cooling. Housing inflation has plummeted from 3.6% to 3.0% annually, and the core services are becoming the main ally of disinflation. Labor market data also continues to show resilience: new jobless claims remained at 224,000, slightly below expectations, suggesting that November did not bring significant deterioration in employment.

The Market Reacts, but the Fed Remains Divided

When the news is good (apparently), risk assets soar. Nasdaq 100 futures gained over 1%, Treasury yields declined, and the probability of a rate cut in January rose from 26.6% to 28.8%. The euro gained nearly 30 points against the dollar, while the yen saw the USD plunge by 40 points.

What numbers don’t fully capture is the internal debate within the Federal Reserve. The December decision to cut rates by 25 basis points recorded 3 dissenting votes out of 12—the first time in six years. Kansas City Fed President Schmid and Chicago Fed President Goolsbee preferred to keep rates steady. Meanwhile, Governor Milan advocated for an even more decisive cut.

Brian Jacobsen, Chief Economist at Annex Wealth Management, warns against dismissing this report as unreliable: “Some may ignore these signs of cooling, considering them ‘less credible than usual,’ but running this risk entails real costs.” Doves within the Fed would likely agree, seeing this report as justification to continue easing.

The Fed’s Dot Plot Tells a Different Story from Reality

The median dot plot projects rates at 3.4% in 2026 and 3.1% in 2027—aligned with September, suggesting 25 basis point reductions per year. But individual officials’ opinions paint a much more fragmented picture. Bostic, President of the Atlanta Fed, openly stated he did not include any cuts in his 2026 forecast, believing that with GDP growth around 2.5%, policy should remain restrictive.

BlackRock, on the other hand, foresees a different path: a move toward 3% by 2026, more aggressive than the median. This gap is not accidental; it reflects the clash between the Fed’s official guidance and what the market actually prices in.

As 2026 approaches, the Fed will end its (almost three-year) quantitative tightening and will launch the new “Reserve Management Purchases” mechanism in January 2026. Officially, it’s just a technical matter to manage liquidity. But the market sees it as a disguised easing, another arrow in the quiver of doves.

Different Paths, Same Uncertain Horizon

Wall Street speaks many languages when it comes to forecasts for 2026. ICBC International predicts total cuts of 50-75 basis points bringing rates back to the “neutral” 3%. JPMorgan is more conservative, believing that the strength of fixed investments supports the economy, limiting cuts to between 3% and 3.25%.

ING outlined two extreme scenarios: one where the economy deteriorates and the Fed cuts aggressively (pushing the 10-year Treasury yield toward 3%), and another where premature or excessive easing fuels inflation concerns and pushes yields toward 5%.

For Investors: The Time for Careful Calculations

If November’s CPI won’t change the Fed’s decision to hold steady in January, it will certainly amplify the dovish voices within the institution. December data will be crucial: if this trend continues, the Fed will reconsider its rate cut path for 2026.

BlackRock suggests a nuanced strategy: allocate liquidity in short-term Treasuries or diversified bonds; increase medium-duration bond holdings; build a ladder of maturities to lock in yields; seek opportunities in high-yield and emerging market securities.

Kevin Flanagan of WisdomTree offers a colder perspective: the Fed is now a “divided house,” and the threshold for further easing remains high. With inflation still about one percentage point above target and the labor market holding steady, consecutive rate cuts remain unlikely unless there is a significant cooling in employment.

The Spectrum of Political Pressures and Leadership Change

A factor few openly discuss: Powell’s term ends in May 2026. A new Fed leadership could alter both the tone and substance of monetary policy. Elections and political pressures on the new chair could push for even more decisive easing than the dot plot suggests.

When the dollar collapsed and gold rose after November data, it wasn’t just a reaction to the numbers. It was the market pricing in cracks in the Fed hawks’ fortress and the quiet strengthening of the doves. Jacobsen is right: ignoring these signals is risky, regardless of the underlying statistical flaws.

The next chapter will depend on December data and how the Fed communicates its outlook. As long as inflation continues to surprise to the downside and the labor market remains resilient, the market will keep pricing in cuts beyond the dot plot. The Fed may find itself having to choose between sticking to its cautious guidance and responding to the rapidly evolving economic realities.