Walmart is not doing so well

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Retail stocks are under pressure premarket Tuesday after Walmart (WMT) laid out a dismal consumer landscape when it preannounced results late yesterday. The retail giant cut its Q2 and full-year profit outlook, noting that while it is attracting customers, their spending is eaten up by higher food and gas prices. That’s forcing markdowns in other items like apparel, hitting Walmart’s margins.

The increasing levels of food and fuel inflation are affecting how customers spend, and while we’ve made good progress clearing hardline categories, apparel in Walmart U.S. is requiring more markdown dollars. We’re now anticipating more pressure on general merchandise in the back half.

Walmart CEO Doug McMillon

Walmart is down 10% before the bell. Major retailers followed, with Target (TGT) down 5% and Amazon (AMZN) off 4%. Grocery stocks like Kroger (KR), down 3%, are also under pressure after Walmart specifically cited high food prices. To put the move into perspective, while today would be the second time this year WMT has gapped down 7% or more at market open, that has only happened 10 times since 1985, according to Bespoke Investment Group.

Is this a retail sector problem? Or is this a company problem? It’s up for the investors to decide.

Walmart framed its numbers as a broader problem of higher prices for essentials hitting other categories (indeed its same-store sales will be above consensus at 6%). But it also echoes the inventory mix issues that Target warned about at the start of June.

Walmart has too much in stock.

The guidance is “not a comp problem with 6% (same-store sales) and reiteration for F/Y BUT a mix issue with higher sales of lower margin food/consumables. Not a surprise but they are not alone,” Stephanie Link, strategist at Hightower, tweeted.

Gas prices are actually down since the last time WMT gave financial guidance, so it may be a case of the retailer using the macro backdrop as an excuse for getting caught flat-footed on its clothing inventory. But if it is a symptom of crumbling U.S. consumer, how will that affect Fed thinking as the FOMC starts its two-day meeting?

Fed factor: Walmart’s warning will give the Fed pause, but will it prompt the Fed to pause?

Recent weak economic indicators have already raised some problems for the FOMC’s very hawkish path. But it can also be argued that deflation on non-essentials like Walmart is seeing is exactly what the central bank wants and will only galvanize it to keep hiking sharply.

“The Federal Reserve is in a tough spot, as inflation is still raging and the economic backdrop has dramatically deteriorated since its last meeting in mid-June,” Danielle DiMartino Booth, CEO and chief strategist of Quill Intelligence, said. “All signs point to an economy in recession.”

The consensus is still for a hike of 75 basis points tomorrow, but that has come down since yesterday with odds of a full-point hike edging up to 27%. That could indicate bets that the Fed will surprise with a mega-hike and then look to pause quickly.

Some of the recent rally “may be the equity market looking forward to the Fed’s eventual attempt to save the cycle from recession and with time running short on that front, that opportunity is now or never,” Morgan Stanley’s Mike Wilson wrote.

“Part of the reason is the fact that they are having their desired effect on demand and so it seems quite plausible inflation could look considerably lower in 6 months time,” he said, but he also predicts the Fed will pause too late. But 100 basis points would “shock the markets,” Booth said. “Bond sales have collapsed in recent weeks, amid signs of stress emerging in the U.S. corporate debt market, and a 100-basis point rate hike would risk further depleting liquidity from the issuance market.”

“The continuation of quantitative tightening, which only began last month, remains a clear and present danger to markets,” she added. “The Fed’s last foray into quantitative tightening in 2018 greatly disrupted markets and this current foray is of a much greater magnitude.”