November Inflation Data Gave the Stock Market a Nice Holiday Surprise, But Economists Are Sounding the Alarm

With just days remaining in 2025, investors received a pleasant surprise, as the November inflation data recently came in significantly lower than expected. This would seemingly signal that the Federal Reserve can worry less about inflation and focus more on the deteriorating labor market, which may necessitate additional interest rate cuts in 2026. However, economists are sounding the alarm on this belief, telling investors to sit tight, as there is more to the recent inflation report than meets the eye.

The shutdown is likely skewing numbers

High inflation has been a persistent problem for investors and the Federal Reserve because it has stirred up concerns over stagflation. This is when consumer prices remain elevated, significantly above the Fed's preferred 2% target, while unemployment creeps up.

This scenario would put the Fed in a bit of a pickle regarding its dual mandate of stable prices and maximum employment. In this scenario, if the Fed lowers interest rates, it can help the labor market, but it also risks reigniting inflation by overstimulating the economy. Meanwhile, if it keeps interest rates elevated, the Fed may eventually stamp out inflation, but risks unemployment rising to undesirable levels.

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Recently, the Bureau of Labor Statistics released the November Consumer Price Index (CPI) report. The CPI tracks the prices of a range of consumer goods and services, and is viewed by many as a key gauge for inflation. November data showed that the CPI rose 2.7% year over year, which is significantly less than the 3.1% economists expected.

At face value, this could be viewed as good news because it indicates that prices are firmly coming down, allowing the Fed to focus on the labor market. This shift means the agency would be more likely to impose additional rate cuts in 2026, often a bullish scenario for equities. However, economists caution investors from reading too much into the report, suggesting the data was likely heavily impacted by the government shutdown earlier this year.

Here are the reactions from several economists immediately following the report, and as reported by CNN:

• "That was one flawed report," RSM US chief economist Joe Brusuelas said. "Due to the government shutdown, the BLS did not have the resources or the time to conduct a complete report."
• "Take it with the entire salt shaker," was the title of a Wells Fargo research report, authored by economists Sarah House, Michael Pugliese and Nicole Cervi. "CPI data are not revised, and as a result we believe the data will be noisy for at least another month or two... A bounce back in prices in the December CPI report to be released on January 13 is probably coming."

In his blog post, Brusuelas noted that because the BLS didn't issue an October report, it's difficult to see what caused the sudden decline in inflation. Brusuelas also stated that by backing out housing data, the November report implies that BLS assumed that rent and owners' equivalent rent didn't rise at all in October, which seems unlikely, given other publicly available data.

The report could have still been positive, but has too many unknowns

Economists are certainly making sense here, as there wasn't a complete data set, so I wouldn't read too much into the report. Unfortunately, investors will need to continue their wait-and-see approach until further data becomes available.

On the bright side, this report could still end up being positive. The stock market seeks lower inflation, which investors believe will lead to more rate cuts, but if inflation falls too quickly, as seen in this report, investors can become nervous about an impending recession. Economists who were polled called for the CPI to come in around 3.1%. A reading of 2.9% or 3% would have likely been perceived positively by the market, simply because it came in below expectations.

President Donald Trump's tariffs are expected to cause a one-time increase in inflation. The question is whether that bump has already occurred, or if it play out over a longer time period. Investors are seeking tangible evidence -- and likely a few months of data showing a clear trend -- that inflation is on the decline. Until that happens, the threat of stagflation will remain.

Wells Fargo is an advertising partner of Motley Fool Money. Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.