What the RBA Won't Tell You About Interest Rates

Welcome to the drama that is the Reserve Bank of Australia's (RBA) monthly interest rate decision. I couldn't sleep last …

a woman

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Welcome to the drama that is the Reserve Bank of Australia's (RBA) monthly interest rate decision.

I couldn't sleep last night. The anticipation was too great. Will they or won't they raise interest rates at 2.30pm AEST today?

Traders have put an interest rate rise happening today at around 10%. I put it at closer to 0%. It will be a bigger non-event than a Kylie Minogue concert.

The reason? Look no further than Wall Street and the S&P 500 index. Off another 1% overnight, it is now down 5.7% since the beginning of May.

Here in Australia, the S&P/ASX 200 index is down 8.5% since mid-April. We're just another bad Wall Street day away from an official stock market correction.

What Glenn Stevens won't tell you

Our economic well-being is more closely tied to the stock market than many people might imagine. A falling stock market will be the main reason why the RBA won't move on interest rates today. But don't expect Glenn Stevens to tell you that.

Most of us have our superannuation invested in the market. A decent chunk of us, and presumably almost all Motley Fool readers, have direct share investments.

Hands up if you own one of Commonwealth Bank (ASX: CBA), Telstra (ASX: TLS) or Woolworths (ASX: WOW). Yep, count me as having a beneficial interest in all three.

Stating the obvious, when equity markets fall, so do the net assets of most Australians. Couple that with house price falls, and suddenly, collectively, we don't feel quite as financially secure.

Good Fool, bad Harvey

It's these reasons why the savings ratio has soared to 11.5%.

Such a ratio is music to the ears of The Motley Fool, as we think too few people save and too many live above their financial means, but it's the worst nightmare for beleaguered retailers like Myer (ASX: MYR) and Harvey Norman (ASX: HVN).

How soon before Harvey Norman are offering 2,000 interest-free days on the latest and greatest home theatre kit? No Harvey No.

In the Australian Financial Review, Merrill Lynch said the sharply increased savings ratio has kept $17 billion away from consumer spending. That's a lot of flat screen TVs, lounge suites and Jimmy Choo shoes. No wonder Gerry Harvey is crying into his billions.

Skid row

Back to the markets. A weak Wall Street over the past month or so is nothing particularly earth shattering, especially when you consider the S&P 500 has risen 21% over the past 12 months. In that context, what's wrong with a little profit taking, or a pause for breath?

I'll tell you what's wrong…the U.S. economic recovery has hit the skids. Job creation in May fell to just 54,000, down from 232,000 in April. Unemployment rose to 9.1%. House prices continue to fall, as does business confidence.

Last week, U.S. stocks fell for a fifth straight week, the longest slump for the Dow Jones Industrial Average since 2004.

"The economy is in a soft patch that places pressures on equity prices", said PIMCO's Mohamed El-Erian on Bloomberg.

More dramatically, BlackRock's Russ Koesterich said "The jobs report is the last nail in the coffin. It confirms that the economy is dramatically slowing."

BlackRock is the world's largest asset manager. You'd reckon they know a thing or two about the economy and the stock market.

We're still singing

What's all that to do with Australia? Like it or not, our stock market still sings to Wall Street's tune. What's good for the Dow is good for the All Ordinaries. And what's bad is even worse.

Take a look at the chart below. The red line is the U.S. market, as measured by the S&P 500, over the past 12 months. The blue line is the local market, as measured by the S&P/ASX 200, over the same period.

Source: Google Finance

Mind the gap. Them up 22%. Us up 5%. Bloody Yanks.

I thought Australia was supposed to be the booming economy, with unemployment below 5%, interest rates at 4.75% and enough commodities to keep us all in huge, unaffordable, air-conditioned, carbon emitting houses for decades to come?

Investing can be cruel.

No pain, no gain

But where there's pain, there's the potential to gain. We may not be there yet, but falling stock markets gives investors the opportunity to pick up some great companies on the cheap. It's why we invest.

Giles Keating of Credit Suisse was recently quoted in the AFR as predicting the market will bottom out over the next month and a re-acceleration of global equity markets is imminent.

What's not to like about a good old fashioned stock market correction? If Mr Keating is right, we may not have too long to wait.

And as for interest rates, of course I could be wrong. The RBA could put them up, the $A would soar, but manufacturers, retailers, first home buyers, house prices and the share market would all cry foul. Today Tonight would have a field day in the mortgage-belts.

You be Glenn Stevens. What would you do? All will be revealed at 2.30pm AEST. Check out The Motley Fool's Facebook page for our instant reaction (and 'like' us whilst you're there).

Happy investing.

Of the companies mentioned above, Bruce Jackson has a beneficial interest in Commonwealth Bank, Telstra and Woolworths. The Motley Fool has an instantly likeable disclosure policy.

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