Relax, the Fed isn’t risking a 1937-style slump

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The world's biggest hedge fund is scared that a U.S. interest rate hike later this year will send markets into a 1937-style tailspin, but experts told CNBC that they aren't too concerned.

In a note to clients that was widely-discussed on Tuesday, Ray Dalio, founder of the $165 billion hedge fund Bridgewater Associates, raised concerns that a Federal Reserve rate hike in June or September could create a market rout similar to the one seen in 1937.

Bridgewater highlighted several similarities between current financial market conditions and 1937: The economy is rebounding, interest rates are at zero and asset prices are enjoying a strong rally. In 1937, the U.S. central bank tightened monetary policy under the belief that the downturn arising from the 1929 Great Depression was over, but its actions tipped the country back into a recession and saw the Dow Jones Industrial Average lost half its value in a year.

"I don't think we're in for a replay of 1937," Jeffrey Franklin, professor of capital formation and growth at the Harvard Kennedy School, told CNBC on Wednesday. "The situation was pretty different. When the government prematurely re-enacted fiscal and monetary tightening back then, unemployment rates were still sky high."

However, the current strength of the U.S. labor market has been a defining feature of the economic recovery. Data for February showed unemployment falling to its lowest level since 2008, while the creation of 295,000 jobs was the strongest in three months.

Rate increases may not have been the sole reason behind the 1937 stock market crash, Marc Faber, editor and publisher of The Gloom, Boom & Doom Report, told CNBC, so investors must keep that in mind when making comparisons.

Dalio's assertions and the debate it sparked come ahead of the Federal Open Market Committee's policy decision later on Wednesday, where the majority of traders expect the central bank to remove the word 'patient' from its policy statement.

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Slow and steady

Officials are aware of the risks behind raising rates too fast and will likely start with a tiny increase, which should mitigate market damage, said John Carey, executive vice president and portfolio manager of Pioneer Investments.

"The general view is that they might start with a quarter of a percent and see what happens. The upper end of their interest rate target may be around 2 percent within the next couple of years assuming the economy continues growing," he added, noting that markets have already priced this possibility into stocks.

A rate hike will be conducted like "a surgical procedure," economists at Mizuho Bank said in a note on Wednesday, adding that the Fed will ensure that the initial hike won't be confused for an aggressive hiking cycle.

Several investment experts don't expect any major market declines when a rate hike does eventually occur.

"Our internal view at Cumberland Advisors is that the first rate hike will not trigger a market selloff," said David Kotok, chief investment officer at Cumberland in a note on its website last month.

"Further, we do not expect the bond market to sell off and interest rates to go shooting up when the Fed raises the interest rate from zero by an eighth or a quarter percent."