The chairwoman of the US Federal Reserve has saide that the case for an increase in short-term interest rates has strengthened, signalling an increase in the probability of a rate hike in the coming month. There are some facts supporting the rate hike. Firstly, the Fed believes the inflation rate will soon return back to its target, 2%. Secondly, the firm job growth shows the strength of the current US economy and the confidence of the market. Thirdly, though the US economic growth of the second quarter falls to 1.1%, the consumption spending remains strong and the third quarter performance seems very strong so far that the Atlanta Federal Reserve predicts that the economic growth has accelerated to 3.4%. Based on these facts, the US Federal Reserve believes it is a good time to increase the rates.
The financial market may dislike the idea of high interest rates, as it means an increase in transaction costs to many institutions, as we can see today's US stock index turns red. However, such action could bring the stability to the market. The increase in short-term interests may force the deposit interest rates stay in the positive zone, so people and companies can safely save their cash in their bank accounts without fearing having negative returns. Moreover, it increases the cost of borrowing, so some firms have to be more careful when they are issuing bonds or directly borrowing from financial institutions. This could cool down the increasing danger of defaults, and improve the stability of the financial markets, as the securities issued by companies with very high debt to equity ratios could create instability in the market. However, this could be the danger of the rate hike that it may burst the bubble created by the increasing number of new bonds issued.
To conclude, the rate hike could improve the stability of the market, but it can burst the bubble and increase the defaults sharply in a short period.
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