Nov PCE Preview: The Key Fed Inflation Gauge Expected to Be Below 3%, But the Red Sea Crisis Adds New Variables

The Bureau of Economic Analysis will release the Personal Consumption Expenditure and the price index at 8:30 ET on Friday. The price index is expected to drop to 2.8% YoY in November from 3.0% in October, and the core PCE price index is expected to fall back to 3.4%.

■ Accommodation pressures are easing amid a surge in new home construction

The decline in accommodation costs might be the main factor driving the decline in the core PCE price index in November, which may make Powell's previous dovish statements more emboldened.

New-home prices on a three-month moving average are down roughly 15% from the peak of late 2022, reflecting homebuilders' aggressive use of base-price reductions and an increasing shift to homes with lower square footage. Bloomberg expected a transition to a smaller product with fewer amenities would drive further reductions in average selling prices. As home ownership costs fall, housing prices will also ease the rent pressure.

PCE price inflation is not as dominated by rents as CPI. Rents account for only 15% of the overall PCE basket — less than half the weight rents receive in the CPI. Nonetheless, rents still account for a considerable part of the elevated inflation. UBS projects that in the data released on Friday, 12-month core PCE price inflation excluding housing rents will drop from 2.8% to 2.4% — only 40bp above the FOMC's 2.0% inflation target.

■ Will weakened dollars put pressure on import prices?

The passthrough from import prices to the CPI usually occurs over 3 to 6 months. Although the dollar weakened in November, import prices did not rise accordingly. The index declined by 1.4% year-on-year in November 2023, following a downwardly revised 1.8% fall in the previous month. Even excluding food and fuels, the import prices fell by 0.6% YoY.

■ Supply conditions pushed down core goods inflation

Both the ISM and S&P/Markit supplier delivery times diffusion indexes have moved into decreasing territory, though they are less deep than a handful of months ago. Inventory levels remain elevated at general merchandise retailers. These suggest that supply is still improving for core goods, putting some additional downward pressure on price inflation in the coming months.

■ Will the Red Sea incident change the inflation outlook?

Several firms have paused shipments through the Red Sea route after Houthi rebels in Yemen attacked vessels. Analysts have warned that attacks on commercial ships in the Red Sea risk pushing up the price of oil and other goods.

The attacks have already pushed ocean freight costs higher. Since the beginning of the Israel-Hamas war, the Asia-U.S. East Coast prices climbed 5% to $2,497 per 40-foot container, according to the Freightos. However, it was containers/ships that were affected more, and there is no direct evidence that the output of oil-producing countries was affected by this incident.

CME FedWatch shows that the probability of the Federal Reserve cutting interest rates decreased after the Red Sea attacks. However, as the impact of the incident subsided, the market once again bet on the Federal Reserve maintaining a dovish stance.