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Barclays, Credit Suisse and Coutts consider the implications of looming interest rate rises
05/08/2014 , Will Grahame-Clarke

With interest rates widely predicted to rise in the UK before Christmas and early next year in the US, leading investment professionals consider the consequences.

The consensus on interest rates is broad with UBS, HSBC, Coutts, Credit Suisse among others bringing predictions forward in the past months.

The indications are that interest rates could start to rise as early as the fourth quarter of 2014 in the UK and the first half of 2015 in the US.

UBS predicts a UK interest rate hike will be in November and in the US in the second quarter of 2015 with modest rises after that to 1.5 percent by the end of 2016.

James Butterfill, global equity strategist at Coutts, said the hike would have a cooling effect initially but would represent a buying opportunity: "As evidence of a strengthening US economy continues to mount and expectations for the first increase in US rates are brought forward, this may cause some volatility in US equities in the near term. But we believe the Federal Reserve (Fed) will tread cautiously, and history suggests equities could recover quickly from any rate-hike fears.

"We believe the Fed will avoid a policy error – where rates are either raised too soon, choking off recovery, or too late, allowing inflation to get out of control – and would view any sell-off in anticipation of a rate hike as a buying opportunity."

William Hobbs, Barclays head of equity strategy EMEA, said: "Similarly to the Bank of England, the Federal Reserve could easily be hustled into an earlier rate rise. It is this scenario which has the most potential to cause upset in capital markets in the short term.

"As interest rate rises loom larger plenty of investors will worry that the US economy - for so long a patient in need of monetary A&E - will struggle to digest tighter monetary policy. Such fears could prompt profit taking and swings in risk appetite.

"We don't see interest rates meaningfully altering the trajectory of the economic recovery just yet; we think the US and the UK have long been capable of digesting tighter monetary policy. However, we do expect a little returning strife to capital markets as investors grapple with the end to emergency level monetary policy. In the first instance, this may manifest itself in a reduction in risk appetite hitting equity markets, both developed and emerging, and some of the riskier areas of credit complex hardest.

"Diversification....remains the best defence. We are still urging clients to position themselves for further equity market upside and a potentially torrid time for much of the bond complex in the coming months and years ahead."

Bjorn Eberhardt, global macro research at Credit Suisse, said: "With markets not pricing in a first rate hike until sometime around September 2015, some Fed officials have already indicated that further improvements in economic data may also prompt an earlier rate hike. We still consider the June 2015 meeting as the most likely time for the announcement. In this respect, this year’s Jackson Hole Symposium in August may provide new perspectives about the Fed’s thinking regarding the US labour market and the appropriate monetary policy stance."

Michael Strobaek, global chief investment officer at Credit Suisse, described how the 12 month proximity of a predicted rate hike felt like markets had "crossed an invisible watershed".

Mr Strobaek continued: "Fed has sent signals for many months that rates will start to rise around the middle of next year, soon the simple theory, asset prices should already be on a smooth glide path. Yet, recent weeks have seen high yield spreads abruptly widen some 40bp and the USD has started breaking key barriers (below 1.35 vs. EUR, above 0.90 vs.CHF).

"Markets with significant funded investment, such as forex and some credits, are most likely to be affected,especially as these tend to be 'crowded trades'. Their recent moves may be only forerunners of what will happen as the clock ticks and we approach the 6 month and 3-month barriers, and liquidity may decline for investors slow to exit. In contrast, stockmarkets have little leveraged investment and may see a temporary reaction, but seem fundamentally less vulnerable, especially as the increasingly robust economic growth that would justify Fed tightening would also help under pin valuations."

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