As a Federal Reserve interest rate hike creeps closer, should we remain relaxed about the consequences?

Is this the right time for Fed chair Janet Yellen to raise interest rates? (Source: Getty)

Andrea Cicione, head of strategy at Lombard Street Research, says Yes.

We can’t imagine investors feeling relaxed, with a series of Fed hikes looming, but past tightening cycles have generally been benign for US stocks.

During the last nine episodes, price to earnings multiples have fallen by an average 4.2x, but in seven, earnings per share have grown fast enough to compensate for the multiple contraction.

As a result, equities have generally performed well at times of rising rates, posting average annualised returns of 5.2 per cent (versus 6 per cent during easing cycles).

With the US earnings cycle already very advanced, profits growth may not be as vigorous as in previous tightening episodes, resulting in below-average (or even negative) returns.

While this is a risk, the fact that rates will be rising very gradually and from extremely low levels is an important mitigating factor. Monetary conditions aren’t about to get tight in a hurry.

Stocks may wobble initially, but should continue to perform well for another 12-18 months.

Chris Beauchamp, senior market analyst at IG, says No.

As talk of a 2015 rate hike continues, investors should be cautious. If the world’s most important central bank has locked itself into a tightening cycle, then we could see a number of the assumptions that have underpinned the global economy disappear.

The Fed risks setting off moves out of risk assets at the very moment that confidence in the global economy looks weakest.

The ECB continues to hum and haw about extending QE in the Eurozone, and the People’s Bank of China doesn’t look like it is about to crack on with another round of stimulus.

The Fed has been the most consistent central bank in maintaining accommodative policy, providing reassurance at critical points.

But a move towards higher rates risks undermining growth in many parts of the world, especially in emerging markets.

It could always retreat and cut rates again, but the damage will have been done. The time, it seems, is not yet ripe for a move.

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