2026 will be no easy task for the Fed

Last week brought a deluge of economic data. Headline inflation for November came in at 2.7% year-over-year, which fell below consensus expectations of 3.1%. At first glance, it was a positive surprise and broadly supportive of the Fed’s recent policy decisions. However, the softer numbers in November were largely attributed to a methodological change in the shelter portion and late data collection following the shutdown, which captured a greater share of holiday discounting than usual. While it is challenging to quantify the exact impact, some of these favorable trends could reverse as processes return to normal.

On the labor front, signs of modest softening continue. The latest unemployment rate increased 0.1% to 4.6%, the highest level since 2021. Nonfarm payrolls rose 64,000 in November. While slightly above economists’ expectations, it remains below the 150,000 level often considered a healthy growth rate. Taken together, softer inflation and cooling employment suggest the Fed may need to keep its eye focused more on the job market in 2026, potentially leaning towards easier policy moves. For what it is worth, markets are pricing in two cuts in 2026 — one more than the Fed’s dot plot had suggested.

Meanwhile, soft data raised some additional concerns. Both the S&P Global Manufacturing and Services PMIs declined month over month and fell below expectations. Commentary accompanying the manufacturing report highlighted “the recent economic growth spurt is losing momentum,” and that “firms have also lost some confidence in the outlook and have restricted their hiring in December in accordance with the more challenging business environment.” This commentary does not bode well for a labor market already cooling. The Fed will have a full plate in 2026.