An imperfect report

I almost started believing in Christmas magic after seeing yesterday’s US CPI numbers. Headline inflation fell from 3.0% to 2.7% in November, while consensus had expected a rise toward 3.1%. Core CPI also dropped sharply, from 3.0% to 2.6%, versus expectations that it would remain sticky at 3.0%. A big surprise — perhaps a little too good to be true.

And indeed, behind the scenes, the picture was messier than the beautiful headline figures suggested. October pricing data were missing for several components, prompting EY-Parthenon to label this a “Swiss cheese” CPI report — full of holes.

Crucially, the missing components included one of the most important drivers of inflation: shelter costs, which make up roughly a third of the US CPI basket. Unsurprisingly, if you strip shelter inflation out, life suddenly looks a lot cheaper.

Another key detail: missing data were treated as showing no price growth: an unbelievable statistical malpractice.

Put together with Thursday’s jobs report — which pointed to a softening but not collapsing labour market — the CPI release failed to deliver clear guidance on the inflation outlook. Bottom line: we are no closer to knowing what the Federal Reserve (Fed) should do next than we were before the data.

Some argue that shelter inflation is genuinely trending lower and should exert disinflationary pressure in the months ahead — but likely not as quickly as markets would like. Energy costs will also matter. While US gasoline prices rose only modestly year-on-year, fuel oil prices jumped 11.3%, electricity costs rose close to 7%, and natural gas prices climbed more than 9%. Energy inflation was a major driver of post-pandemic price pressures, so it is far too early to declare victory.

Beyond this imperfect CPI print, I am slowly warming to the idea that US inflation could fall without ever clearly showing the much-anticipated tariff impact in the data. It echoes the US recession that never materialised despite a 26-month inversion of the 2-10-year yield curve. Twenty-six months of inversion — and nothing. This may be heading in a similar direction.

If tariff-led inflation never truly appears and the US labour market weakens, markets face two choices: either believe the data and push equities higher — or believe the Fed and push equities higher. The real question is whether there will be a bump along the way.

Markets, however, briefly celebrated. The US 2-year yield fell below 3.45% before rebounding, the 10-year flirted with 4.10% before retracing, and the probability of a March Fed rate cut rose from around 50% to near 60%.

Market reaction: US equities rallied post-CPI, but enthusiasm faded quickly. The S&P 500 gave back most of its gains, though it still closed about 0.8% higher. Small caps initially outperformed but later surrendered gains, while the dollar reversed early losses and is better bid this morning in Asia.

Ironically, the broader market backdrop is not necessarily bad. AI enthusiasm may be debatable, but Fed expectations are dovish, liquidity conditions are supportive and the case for rotation from tech into non-tech sectors remains strong.

So the Santa rally may be looking a little bruised as we head into Christmas week — but it’s not cancelled yet.

Elsewhere, Europe delivered more traditional central-bank fare. The European Central Bank (ECB) held rates steady at its final meeting of the year, raised its growth forecasts for 2026 and 2027, and reiterated that inflation will only return to target in 2028. In plain English: there is too much uncertainty to commit to a rate-cutting path, and cuts are likely paused for now. The euro weakened as the dollar gained broadly.

In the UK, the Bank of England (BoE) cut rates by 25bp as expected, but the vote split — 5-4 — was surprisingly close. Many had hoped easing inflation and a disinflationary budget would pull some hawks toward the dovish camp. Instead, several MPC members remained unconvinced that disinflation is straightforward. Sterling saw large swings on the combination of a relatively hawkish BoE and questionable US inflation cooling, before coming under renewed pressure as the dollar strengthened.

Elsewhere, the Riksbank and Norges Bank left policy unchanged, while the Bank of Japan raised rates by 25bp to 0.75% — the highest level since 1995. Policymakers stressed that real rates remain “significantly negative” and financial conditions broadly accommodative, implying further hikes ahead. The 10-year JGB yield jumped to 2.6%, not great news for global risk appetite given the risk of Japanese investors repatriating capital from US Treasuries. Yet the USDJPY still rose, as dollar strength outweighed higher Japanese yields.

One final reminder: Fed dovishness alone can offset tighter stances elsewhere. Even as Fed doves scratch their heads, the US central bank remains more dovish than most of its peers, many of whom appear inclined to pause rate cuts next year.