MarketWatch is reporting Core inflation falls back to Fed’s comfort zone.

Core consumer price inflation increased just 0.1% in April, bringing the year-over-year increase down to 2%, just inside the Federal Reserve’s target, the Commerce Department reported Friday.

It’s the first time in 14 months that core prices have been inside the Fed’s unofficial target zone of 1% to 2%. Core inflation peaked at 2.4% in February; it was 2.1% in March. The deceleration in core inflation is welcome news at the Fed, but officials have stressed that they still believe inflation could accelerate again despite the recent improvements.

With the Fed on guard against inflation and brushing off the slump in the economy as temporary, financial markets are no longer expecting any rate cuts from the Fed this year.

The consumer price inflation referred to in the article is the PCE not the CPI but let’s take a look at both starting with the CPI Report released a couple of weeks ago.

Click on chart for a better view.

Looking at the 3 month compounded rate in the core CPI at 1.9% is a PCE report of 2% all that shocking? In fact, other than a big spike in January 2007 when education costs soared the core CPI (items less food and energy) has been tame since October of 2006 .

I spoke with Paul Kasriel at the Northern Trust last Friday asking him about the difference between the CPI and the PCE inflation index. The answer is “Not much. The weightings and the basket are slightly different but they do track together. The PCE has a lower weighting on rent and a higher rating on medical.” Those were the two weighting differences he was aware of off the top of his head (there are others) but essentially it is nitpicking except for the fact that Bernanke likes to use the PCE.

A further conversation revealed we are in sync about jobs. Neither of us believes the birth/death model. “It’s a noble idea in theory but impossible to get right in practice.” We are also in sync about the state of the economy. The Fed seems to believe in some sort of second half recovery but both of us think that housing is going to eventually spillover. It has every other time in history, why should this time be different?

Back to the CPI. Can anyone really take comfort when energy and food prices are soaring? Apparently Bernanke can.

So how did the core CPI drop anyway? The answer lies in the green boxes in the above chart. Recreation rose a mere .1%, other goods and services rose only 2.5%, and apparel prices dropped 3.3%. But how often does one need to buy clothes vs. food or gasoline? If housing costs drop will people be happy or horrified?

Personal Income Plunges

Lost in the ridiculous comfort zone headline was the real news about Personal Income and Outlays.

Personal income decreased $7.1 billion, or 0.1 percent, and disposable personal income (DPI)decreased $9.7 billion, or 0.1 percent, in April, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $52.0 billion, or 0.5 percent.

Wages and salaries

Private wage and salary disbursements decreased $30.7 billion in April, in contrast to an increase of $42.0 billion in March. Private wages and salaries had been boosted by $50.0 billion at an annual rate in January, in February, and in March to reflect unusually large bonus payments and the exercise of stock options. These types of irregular payments are not accounted for in the primary monthly source data for wages and salaries.

Personal saving — DPI less personal outlays — was a negative $132.8 billion in April, compared with a negative $67.8 billion in March. Personal saving as a percentage of disposable personal income was a negative 1.3 percent in April, compared with a negative 0.7 percent in March. Negative personal saving reflects personal outlays that exceed disposable personal income.

Real DPI and real PCE

Real DPI decreased 0.4 percent in April. Real PCE increased 0.2 percent in April. The price index for PCE increased 0.3 percent in April, compared with an increase of 0.4 percent in March. Prices, excluding food and energy, increased 0.1 percent, compared with an increase of less than 0.1 percent.

There was a big whoop to do about the PCE falling back in the comfort zone after this report. Heck, last month it was less than 0.1% (.04% I believe) month over month. The reason for the whoop to do was that year over year the PCE was 2.1% last month and now is sitting at 2% this month. Like any of this matters to the average Joe (as opposed to the average bureaucrat at the Fed) with what energy and food prices have been doing.

The average guy on the street sees falling personal income, falling disposable income, and a negative savings rate shooting back up (this time with no house backed ATM to bail him out).

Ask the average guy on the street if inflation is in the comfort zone. Ask about stock options and enormous bonuses as well. See what answers you get. I have no doubt the latter is enormously skewed. Averaging out those bonuses and options as if everyone shared in them does not paint the correct picture.

At this point I must again point out that my view of inflation is an expansion of money and credit, not consumer prices. Many times (like now) I talk about inflation in terms of the CPI or PCE. The context should be obvious but I will point this out in advance or I will get called on it.

That said, credit expansion shows no signs of abatement either and the evidence is obvious: LBOs, stock buybacks, margin debt, etc are all soaring with bigger and bigger deals. This go around the expansion of credit is primarily reflected in the stock market instead of consumer prices. Should anyone take comfort in that? I think not given the same conditions existed right before the 1929 stock market crash. When this mess implodes, which it will, it will spawn all sorts of Congressional investigations in its wake. Won’t that be a comfort?

Addendum:

I hope everyone finds this new layout more to their liking. The text area is now expandable as opposed to being fixed, there is a new color scheme, and Haloscan commenting has been dropped in favor of JS-Kit. No one at Haloscan has returned Email replies for months about problems we have been having. JS-Kit is already far more responsive. Comments are now threaded as well. If you haven’t tried leaving a comment before, please consider doing so now. Unfortunately prior comments have been lost.

Note that there is a new “Digg” button. I ask that if you like a post to please “Digg It”. I also will be bringing video clips from time to time, in an attempt to enhance the reader experience.

Unrelated to the CPI but a video I think you will find very funny please play this Minyanville video on Hedge Fund Regulation. I think you will.

Click here to see Cox and Balls.

Mike Shedlock /Mish/