If markets hope to recover from the sharp sell-off triggered by the Federal Reserve’s December meeting, Friday's release of the Personal Consumption Expenditure price index — widely regarded as the Fed’s preferred inflation measure — will play a crucial role.

Unfortunately for investors, the outlook is far from reassuring.

Scheduled for release at 8:30 a.m. ET Friday, economists expect the PCE price index to climb to 2.5% year-over-year in November 2024, up from 2.3% in October. This would mark the second consecutive monthly acceleration in the headline figure.

On a monthly basis, the index is projected to increase by 0.2%, maintaining the same pace as the prior two months. If realized, this would indicate that price pressures over the past three months are growing at an annualized rate of 2.4%, exceeding the Federal Reserve's 2% inflation target.

Core PCE, which excludes volatile food and energy prices, is forecasted to rise slightly from 2.8% to 2.9% year-over-year in November. This would also represent a second consecutive increase, signaling persistent inflationary pressures in the underlying components of the economy.

On a monthly basis, Core PCE is expected to decelerate, rising by 0.2%, down from 0.3% in October.

Fed's Revised Inflation Narrative, Hawkish Language

The Federal Reserve's updated inflation projections unveiled Wednesday painted a hotter-than-expected picture for 2025. Policymakers now anticipate headline PCE inflation at 2.5% next year, up from the 2.1% forecast in September.

Similarly, core PCE inflation is projected to hit 2.5%, compared to the prior estimate of 2.2%.

This upward revision underpinned the Fed's hawkish tone during its policy meeting.

Officials signaled a cautious approach to rate cuts, forecasting just two rate reductions in 2025, a sharp downgrade from the four cuts previously projected.

Fed Chair Jerome Powell reinforced this message during the post-meeting press conference, stressing the need to avoid premature policy easing.

“From here it's a new phase and we're going to be cautious about further cuts,” Powell said.

The Fed chair didn’t rule out the possibility of an interest rate hike next year. "You don't rule things completely in or out in this world. That doesn't appear to be a likely outcome," he said.

Market Implications: Crucial Inflation Test

Recent inflation data has sent worrying signals to markets.

While last week's Consumer Price Index rose as expected, the hotter-than-predicted Producer Price Index raised concerns about potential upward momentum in prices.

Friday's PCE report could tip the scales, either bolstering the Fed's cautious stance or providing investors with reasons for optimism.

Bank of America's latest forecast sees core PCE rising by 0.1% month-over-month in November, slightly below consensus expectations. A 0.1% increase would offer the Fed a welcome reprieve following two consecutive 0.3% monthly gains, though it would leave the year-over-year rate unchanged at 2.8%.

"If correct, it would be a relief and make us less worried about the recent trajectory of inflation," said Bank of America economist Aditya Bhave.

While progress on inflation has stalled above the Fed's target, the latest trends do not suggest a significant reacceleration is underway, the economist said.

How Markets Could React

A lower-than-expected PCE report could offer relief to equity markets, helping reverse some of the steep losses sustained in the aftermath of the Federal Reserve’s hawkish December meeting.

Conversely, any confirmation of persistent inflation, or worse, an upside surprise, may extend the pain for investors.

The S&P 500 index, represented by the SPDR S&P 500 ETF Trust ( SPY ) , dropped 3% on Wednesday following the Fed meeting, logging its worst single-day decline since September 2022.

The Dow Jones Industrial Average fell 2.6%, extending losses for the tenth straight session, the longest negative streak since 1974. The index is tracked by the SPDR Dow Jones Industrial Average ETF Trust ( DIA ) .

Tech stocks — also tracked by the Invesco QQQ Trust, Series 1 ( QQQ ) — fell even more, down 3.6%.

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