The signal of the Fed's rate cut hidden in US retail stock earnings reports

McDonald's launches $5 combo, Target shifts to a low-price strategy, Walmart's stock price runs on an "independent trend"...

US retail giants have revealed a signal: Americans are downgrading their consumption. As the "economic pillar of the US" consumer spending shows cracks, this gives the Federal Reserve a reason to cut interest rates.

Retailers' financial reports reveal American consumption downgrade: Focus on essential consumption, preference for low-priced goods

In the past two weeks, the market has seen a wave of financial reports from US retail giants - including Walmart (WMT.US), Target (TGT.US), and Macy's (M.US) among others.

From the financial reports, it can be observed that in the face of continued high inflation in the US economy, consumers are affected by tightened wallets and discounted prices. The trend of consumers reducing non-essential spending and preferring low-priced goods has a greater impact on high-end department stores and retailers of large non-essential items than on discount stores and retailers specializing in essential consumer goods.

Unwillingness to purchase non-essential items at high prices

Although American consumers continue to spend, there are signs that the momentum is slowing down. In the food and beverage sector, popular chains like Starbucks (SBUX) and McDonald's (MCD.US) have seen a decline in same-store sales in the US as consumers resist price increases. The tourism industry is also starting to feel the impact. Disney (DIS.US) has also indicated a decrease in attendance at its popular theme parks, while airlines and hotels have noted a softening in leisure demand.

Against the backdrop of underperforming performance by these consumer giants, Walmart, Costco (COST.US), and other large discount retailers have been able to frequently show an "independent trend", surprising investors. In contrast, Home Depot (HD.US), Lowe's (LOW.US), and other retailers in the home improvement sector with weak performance indicate consumer weakness, further demonstrating a reluctance to splurge on non-essential items.

Due to rising borrowing costs and soaring inflation, consumers have postponed large projects such as flooring, kitchen cabinets, and bathrooms. Both Home Depot and Lowe's reported a decline in Q2 same-store sales, leading to a significant drop in stock prices post-earnings. Analysis points out that the reason lies in the relatively high prices of home improvement and other large non-essential items, causing consumers to delay spending.

Another example of American consumers cutting back on consumption is seen in Target's stock price lagging significantly behind Walmart, as Target has a large exposure to non-essential items; while Walmart benefits from its extensive business in groceries and other essential items.

Retailers lower prices for promotions, discounts more welcomed by Americans

Taking Walmart, the largest retailer in the US, as an example, its second-quarter performance announced last week exceeded expectations once again, while continuing to raise full-year revenue and profit guidance, as its customers are attracted by lower prices and convenient delivery methods. During inflation, Walmart's performance overall outperforms other retailers because it sells mainly groceries and has long been a price leader, deriving pricing power from its scale and passing this pricing power on to customers, making it suitable for consumers to buy cheap essential goods in the context of inflation and high interest rates.

Although low- and middle-income shoppers have always been Walmart's core customer base, Walmart has recently also been attracting customers with annual incomes exceeding $100,000, expanding its market share Walmart stated that in the last quarter, it continued to expand its market share in high-income households. As high-income consumers reduce spending or seek discounts, Walmart's decision to offer more discounts, new products, and store renovations is benefiting the company.

Walmart has also tasted success with its low-price strategy. Walmart CEO Doug McMillon stated that more than half of Walmart's sales come from groceries, priced about 25% lower than traditional supermarkets. The company also temporarily reduced prices on 7,200 selected items, with overall prices at Sam's Club member stores slightly lower than the same period last year.

This week, the performance of Target, Ross Stores (ROST.US), TJX Companies (TJX.US), and Peloton (PTON.US) continued to strengthen the trend seen as "value-oriented" for retailers.

Discount retailers like Target seem to be better positioned to benefit from price-sensitive consumers. Executives stated that in May this year, Target announced moderate price reductions on 5,000 food and household items, leading to an increase in foot traffic. Target announced on Wednesday that its comparable sales increased by 2% in the three months ending August 3, exceeding expectations. Discretionary spending has also increased, especially in the clothing business.

Target CEO Brian Cornell stated in a conference call with analysts that consumers still have elasticity. He added that they "continue to focus on value while managing household budgets."

In addition, discount retailer TJX Companies also reported better-than-expected quarterly performance on Wednesday, with comparable sales increasing by 4%. The company raised its pre-tax profit margin expectations for the year. Due to demand for its discount clothing and lower shipping costs, Ross Stores' second-quarter performance announced on Thursday also exceeded Wall Street expectations, and the profit forecast for the 2024 fiscal year was raised.

In contrast, the largest chain department store in the United States, Macy's, reported a decline in same-store sales in the second quarter and expects full-year revenue and same-store sales to decline, mainly due to the company's market positioning towards mid-to-high-end users with limited pricing elasticity. Even though this retailer was forced to lower prices and offer more promotions on mid-to-high-end products to compete with reasonably priced competitors, it still suffered losses in sales.

Macy's struggles to attract cost-conscious customers due to its outdated store format. H Squared Research Chief Research Officer Hitha Herzog stated: "These stores are large in scale and the products they offer are not appealing. When you combine this with price-sensitive customers, you don't see a shift in sales. Focusing on smaller stores may help, but the days of people shopping and spending a day in large stores in their current form are over "

LPL Financial's Chief Global Strategist Quincy Krosby said that the difference between struggling department stores and thriving discount retailers highlights a consumer trend: despite cooling inflation, shoppers are becoming "increasingly cautious and picky."

Increased Pressure on American Consumers

Research released by the San Francisco Fed this month shows that for the top 20% of American households by income, liquid assets (including cash and savings, funds in checking and money market accounts) rose significantly from 2020 to early 2021. They then gradually declined and are now about 2% lower than expected without the impact of the pandemic.

However, for other American households, the growth in these liquid assets has been smaller, and excess assets were depleted earlier, now about 13% lower than the pre-pandemic forecast path. At the same time, compared to high-income households, the credit card delinquency rate for these middle and low-income households increased earlier, faster, and "significantly higher." Economists say that the reduced financial buffers and increased credit pressures for the bottom 80% of households pose risks to future consumption growth.

To meet the high cost of living today, many American households have depleted their savings and are deeply in debt. Faced with high interest rates, American households are paying over $300 billion in credit card interest for the first time each year. As debts come due, people are forced to cut spending and lower their living standards.

Data shows that credit card debt alone has reached a record $1.14 trillion, and total household debt in the United States has ballooned to a staggering $17.8 trillion. Faced with high interest rates, American households are paying over $300 billion in credit card interest for the first time each year. As debts come due, American households are forced to cut spending and lower their living standards, which is expected. Chicago Fed President Gulbis previously stated that the rising credit card default rate is one of his concerns, and he believes it may be a signal that policy tightening is exceeding what is necessary.

This means that liquid resources such as bank deposits held by American middle and low-income households are significantly lower than before the outbreak of the COVID-19 pandemic, creating financial pressure and posing risks to the backbone of the U.S. economy—consumer spending.

Consumer spending is the biggest driver of U.S. economic growth, accounting for about two-thirds of U.S. economic output, making retail sales particularly important. Due to rising costs leading to tight budgets, and with savings nearly depleted during the pandemic, many other consumer-facing companies are presenting dim prospects.

John Zolidis, founder of investment advisory firm Quo Vadis Capital, said this is "not a truly positive, thoroughly cleansing signal." He said, "If you look at the vast amount of data we see and all the company comments, we are still in a weak consumer environment. That's the conclusion I expect from retailer reports."

Reasons for the Fed to Cut Interest Rates

Consumer spending and the labor market unexpectedly performed well during the Fed's rate hike period in 2022-2023, boosting policymakers' optimism. Fed officials believe they can contain inflation without triggering an economic recession and a sharp rise in unemployment, which is a rare economic "soft landing."

" Federal Reserve officials have previously stated that the sustained strength of the real economy gives them room to maintain the policy interest rate in the current range of 5.25%-5.50% to maintain downward pressure on inflation.

However, the situation may be changing now. With the flashing yellow light on U.S. consumer spending, an important support behind consumer spending—the U.S. labor market—is also showing signs of slowing down. The U.S. Bureau of Labor Statistics announced on Wednesday that nonfarm payroll employment was preliminarily revised down by 818,000 people in the 12 months ending in March 2024. U.S. job growth may not be as strong as previously reported, providing a reason for the Federal Reserve to cut interest rates next month.

The latest meeting minutes released by the Federal Reserve also show that many participants pointed out that reported job growth may have been exaggerated, with some participants assessing that job growth may be below the level needed to keep the unemployment rate unchanged when the labor force participation rate is stable. In addition, participants noted that other indicators also indicate some easing in the labor market conditions, including a decline in hiring rates and a downward trend in job vacancies since the beginning of the year.

For consumers, there are more worrying signs beneath the surface of the job data report. The number of part-time workers looking for full-time work has increased, and weekly working hours have slightly decreased, both signs that workers are taking home less pay. Economists say that if this trend continues, it could trigger a destructive economic cycle with broader implications. This could lead to more constraints on consumer spending, resulting in income declines, prompting companies to lay off workers, forming a self-fulfilling spiral of negative feedback.

Cayla Seder, macro multi-asset strategist at DWS, said: "Taking all factors into consideration, recent data suggests that consumption is slowing down. This is consistent with the Fed's readiness to begin a slow rate cut. Our current situation and the financial reports highlight that more and more consumers are making challenging choices. However, spending does not indicate that we are at the bottom of the economic cycle."

Currently, the market is convinced that the Federal Reserve will start cutting interest rates in September, with the question being whether it will be a 25 basis point cut or a 50 basis point cut. According to the CME FedWatch Tool, investors are generally betting on a 25 basis point cut in September, with a 26.5% chance of a 50 basis point cut.

In response, the market will focus on Powell's speech at the Jackson Hole Global Central Bank Annual Symposium later on Friday. Most analysts believe that Powell will indicate in his Friday speech that the Fed is confident that inflation is returning to the 2% target, and may even hint at how many rate cuts there will be this year During the press conference held after last month's Federal Reserve meeting, Powell stated that by the end of the year, it is possible to go from "zero rate cuts to several rate cuts"