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Wal-Mart: One more reason the Fed should not hike rates

With sentiment rising that the Federal Reserve will delay raising interest rates at September's meeting of the Open Market Committee, Wal-Mart Stores' weak earnings report yesterday added one more reason to bet against the first rate hike in nine years.

The price of Fed Funds futures after Wal-Mart's report pointed to a 36 percent chance of a September rate hike—down 9 percentage points since Monday, according to the CME FedWatch.

Wal-Mart is not only the nation's biggest retailer by sales but is keenly focused on the middle-income families whose lost ground on wages has helped convince the central bank to hang on to its stimulative monetary policies even as onetime thresholds for rate hikes have been achieved. Wal-Mart's inability to boost revenue materially points to its own competitive battles against Amazon.com and other retailers, but economists say it also is hampered by the fact that its customers don't have very much money.

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"Wages are always the elephant in the room when it comes to consumer budgets," Moody's Analytics managing director Scott Hoyt said. "Clearly, the lack of growth in wages is a constraint on middle-income folks who aren't benefiting from housing appreciation or a rising stock market.''

Wal-Mart shares dropped 3.4 percent after the company said its $3.5 billion profit for the July quarter, which works out to $1.08 per share, missed a Wall Street consensus forecast of $1.12 a share. The company also lowered its own earnings forecast ranges for the rest of the year, citing a recent wage hike for store associates, lower pharmacy earnings, a strong dollar cutting into overseas sales and increased "shrinkage,'' an industry term for shoplifting and other missing inventory.

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The one piece of brighter Wal-Mart news, from an economic perspective, was that U.S. sales in stores open more than one year rose 1.5 percent, beating forecasts of 1 percent growth. To one economist who expects a September rate hike, that was a sign that conditions are getting better. "The best same-store sales in three years says the economy is on track and consumers are spending," said Joel Naroff, president of Naroff Economic Advisors.

But many economists see a weaker picture, where the expected upward revisions in the government's first estimate of gross domestic product for the second quarter mostly reflect inventory buildup, and where forecasts for the third quarter are cautious. Moody's Analytics, for example, expects the economy to grow only at a 1.9 percent annual rate in the third quarter.

"Take the second- and third-quarter average and it leaves us in the same 2 percent to 2.5 percent range we've been in for the last six years," said Richard Moody, chief economist for Birmingham-based Regions Financial. "What seems really odd is raising interest rates with inflation as low as it is and as low as it is likely to remain."

"People are living paycheck to paycheck and are being careful." -Chris Christopher, consumer economics director, IHS Global Insight

Other mid-priced retailers are also having troubles this quarter. Macy's, Kohl's and Dillard's missed forecasts. On the other hand, mid-priced rival Target beat earnings forecasts in second-quarter earnings announced today. Mid-priced retailers are getting hit all at once by online shopping, deep discounters and luxury brands, IHS Global Insight consumer-economics director Chris Christopher said.

The issue for many retailers in the middle is that their target customer, who lives on wages rather than bonuses, hasn't gotten as big a raise as more-affluent workers, Hoyt said. The median U.S. household income is about $55,132, up 2.1 percent in the last year adjusted for inflation, according to Sentier Research. That's 2.7 percent lower, in real terms, than immediately before the recession, and almost 4 percent less than in 2000.

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The pinch is especially tough for retailers who sell groceries, a category that includes Wal-Mart, Christopher said. Retail sales reports show a pickup in restaurant spending as consumer confidence rises, which oddly hurts grocery sales. Nationally, grocery-store sales have decelerated even as overall retail sales have picked up the pace since May, led by auto sales.

"People are living paycheck to paycheck and are being careful,'' said Christopher, who nonetheless expects overall retail sales to rise about 3.1 percent in the second half as overall growth revives by the fourth quarter.

Like other economists, he said Federal Reserve Chair Janet Yellen has made clear that the Fed is likely to raise rates at least once by the end of the year.

The hope for both Wal-Mart and America is that higher wages like those Wal-Mart is implementing lead to more consumer spending from the middle out, bolstering the economy by next year, much as Henry Ford's famous 1914 decision to double wages eventually led to middle-class workers being able to afford cars, said Jared Bernstein, a senior fellow at the Center for Budget and Policy Priorities.

"Wal-Mart has invested in wages and training, and that cut into margins," Bernstein said. "But that's a necessary cut. We want low- and middle-income workers to see their incomes rise. I actually would consider it a good sign in a Henry Ford sense.''

—By Tim Mullaney, special to CNBC.com