U.S. CPI surprises: The market re-evaluates the path to interest rate cuts

A report on inflation once startled international investors at the end of 2024. When the U.S. Bureau of Labor Statistics announced the November CPI data in mid-December, the financial markets reacted strongly. The inflation data not only came in below expectations but also contained unusual elements, prompting analysts to reconsider the true story behind the numbers. The U.S. dollar suddenly weakened, gold surged rapidly, and U.S. stock futures soared—all signs that the market is reshaping its expectations for future monetary policy.

November CPI Data Shows Unusual Signs

According to the official CPI report, U.S. overall inflation in November increased by only 2.7% year-over-year, significantly lower than the market forecast of 3.1%. Even more notable is the core CPI, which rose just 2.6% year-over-year, below the expected 3.0% and the lowest since March 2021. At first glance, this CPI news seemed to offer hope for those expecting the Fed to continue easing policy.

However, behind these figures lies a more complex story. Due to the U.S. government shutdown in October, the Bureau of Labor Statistics was unable to publish the CPI report for that month. When calculating the November data, they assumed that October CPI had no change, effectively zero. This created a clear statistical “noise” in the CPI figures that few people noticed.

UBS conducted an in-depth analysis and pointed out that this data handling method could have understated inflation by about 27 basis points. Removing this noise suggests that the actual inflation rate might be closer to the initial expectation of 3.0%. Therefore, when analyzing this CPI report, it’s important to understand that it does not fully reflect the real inflation picture.

Internal Dissent at the Fed, Moderates Speak Out

Although the CPI data contains anomalies, it still provides “ammunition” for the dovish faction within the Fed. This internal disagreement was clearly evident in the recent policy meeting. The decision to cut interest rates by 25 basis points was approved with 9 votes in favor and 3 against— the first time in six years the Fed faced three dissenting votes. Fed Kansas City Chair Schmid and Fed Chicago President Goolsbee opposed the cut, advocating for unchanged rates. Meanwhile, Fed Board Member Milan supported a more aggressive rate cut.

This division is also reflected in the latest Fed dot plot. The median forecast for policy rates in 2026 is 3.4%, and for 2027, 3.1%, unchanged from September, indicating the Fed expects roughly 25 basis points of rate cuts annually. However, individual views among Fed officials vary significantly. Atlanta Fed President Bostic even suggested that no rate cuts are expected in 2026, believing the economy will grow strongly at about 2.5% GDP, and that policy should remain restrictive.

Market Reassesses Expectations

The financial market reaction to the CPI data was almost instantaneous. U.S. stock futures rose across the board, with the Nasdaq 100 jumping over 1%. U.S. Treasury bond prices increased, yields fell accordingly, reflecting expectations that the Fed might have more room to loosen policy.

Futures market probabilities shifted notably. The chance of a rate cut by the Fed in early 2025 increased from 26.6% to 28.8%. Additionally, the market anticipates that by the end of 2026, the policy rate could be eased by about 62 basis points.

The U.S. dollar weakened rapidly, with the dollar index dropping 22 points in the short term to a low of 98.20. Spot gold rose $16. Other major currencies also gained: EUR/USD increased nearly 30 points, USD/JPY fell nearly 40 points. This indicates that the CPI news has truly shifted global market sentiment.

The Path Forward for Interest Rates Is Full of Uncertainties

Amid the shock from the CPI data, the outlook for rate cuts in 2026 has become a focal point. Although the official dot plot shows a gradual easing path, analyses from major institutions reveal unprecedented disagreement. BlackRock forecasts the Fed will cut rates from the current 3.50%-3.75% down to around 3% by 2026, below the median 3.4% in the dot plot, highlighting a gap between market expectations and official guidance.

JPMorgan adopts a cautiously optimistic stance, citing the resilience of the U.S. economy—especially strong non-residential fixed investment—as supporting growth. They predict a more limited rate reduction, with rates stabilizing around 3%-3.25% by mid-2026.

ING presents two extreme scenarios. The first: the economy deteriorates significantly, prompting the Fed to loosen aggressively to counteract recession risks, potentially lowering 10-year Treasury yields to around 3%. The second: political pressures or misjudgments lead the Fed to prematurely or excessively loosen monetary policy before economic slowdown, risking loss of credibility and uncontrolled inflation, which could push 10-year yields sharply higher, even challenging the 5% level.

Looking Ahead: Opportunities and Challenges

The labor market will be a key variable. Despite the sharp decline in November CPI, initial jobless claims stood at 224,000—below the forecast of 225,000—indicating the labor market remains stable. CMB International Securities notes that U.S. employment conditions have softened slightly but not significantly. They forecast that in the first half of 2026, inflation may continue to decline due to lower oil prices, rent decreases, and wage reductions, possibly allowing the Fed to cut rates once. However, in the second half, inflation could rebound, prompting the Fed to hold rates steady.

Leadership changes at the Fed will also introduce new uncertainties. Chairman Powell’s term is expected to end mid-2026, and the appointment of a successor could influence the monetary policy trajectory and communication.

Guolian Minsheng Securities analysts believe that while the November CPI is unlikely to alter the decision to delay rate cuts in early 2025, it will certainly strengthen the dovish voices within the Fed. If December CPI continues its slow upward trend, it could prompt the Fed to reconsider its entire rate reduction plan for the following year.

For investors, BlackRock recommends fixed income strategies: investing in short-term Treasury bonds (0-3 months), increasing holdings of medium-term bonds, building bond ladders to lock in yields, and seeking higher returns through alternative assets. Kevin Flanagan of WisdomTree warns that internal divisions within the Fed have become “a house divided,” and the threshold for further easing remains very high. With inflation still about one percentage point above the target, unless the labor market cools significantly, the Fed will find it difficult to decide on continuous rate cuts.

The CPI data has sparked a new debate about the future monetary path. Although the report contains statistical anomalies, it still offers hope to the markets. Whether this is a temporary fluctuation or a genuine slowdown in inflation, the Fed’s next moves will depend on upcoming economic data. The dot plot’s seemingly flat trajectory faces dual challenges from economic realities and market expectations.