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Leading Market Analyst Tells CNBC Why the Fed’s Short-Term Rate Launch May Be Doomed to Return to the Launching Pad

Fort Lauderdale, Fla. – When the Federal Reserve finally raised short-term interest rates from zero to a quarter-percent on Wednesday (Dec. 16), one of the market analysts contacted by the media was Sound Income Strategies Founder David Scranton. Scranton has been on record since last year saying that if the Fed raised rates at all in 2015, it would only be by a fraction of a percent because that was their only option. Following Wednesday’s announcement by Fed Chairman Janet Yellen, Scranton appeared on CNBC’s Closing Bell to explain why he believes the Fed’s plan for gradually increasing rates further in the next two years is hampered by many of the same factors that played into his original forecast.

“When I heard that the anticipated target would be one-and-a-half percent by the end of 2016 and two-and-a-half percent by the end of 2017, I had a tough time believing that for two reasons,” Scranton told Closing Bell moderator Bill Griffith.

Scranton explained that with quantitative easing underway in Europe, raising short-term rates within that timeline would likely cause the dollar to strengthen. If that happened, it would undermine the Fed’s desire to reach a domestic inflation rate of at least 2 percent. The current low inflation rate of 0.5 percent is one of the reasons cited by the Fed for not launching with a more substantial rate hike right off the bat.

The second reason Scranton noted for his skepticism is the same one that formed the basis of his forecast when he told CNBC a year ago, “I don’t think they’re going to be able to raise rates at all or perhaps just a tiny little bit.”

Scranton explained that ever since quantitative easing ended in the U.S. in October of 2014, a downturn in the global economy and ensuing implementation of quantitative easing in Europe has had a “leveling effect” on our long-term interest rates. It’s held long-term rates down overall near 2 percent and may continue to do so for some time. Scranton said this creates a dilemma for the Fed because raising short-term rates too much while long-term rates are suppressed would flatten out the yield curve. He explained that banks depend on the yield curve and need long-term rates to be higher than short-term rates in order to make lending fiscally worthwhile.

“To keep the spread between short-term and long-term rates at about two percent and not compress it, that means that the 10-year treasury would have to be at between 4 and 5 percent,” Scranton told Griffith, “and I don’t see how that’s going to happen at a time when there’s quantitative easing abroad.”

In the end, Scranton said he believes the Fed only approved the small rate increase this time because Chairman Yellen felt she had no choice. “She knew the financial markets were expecting it and didn’t want to risk triggering a slide by backing off, which is just what happened last September when Wall Street was expecting the hike and the Fed voted no,” he said.

The fact that the markets reacted positively to the increase further indicates they had “pre-approved it,” Scranton said, while Janet Yellen’s cautionary tone in the press conference following the vote demonstrated she’s not trying to fool anyone into thinking that the rate hike means the economy is “recovered.” While she did say the move should be seen as a sign of confidence that the economy is “on a path of sustainable improvement,” Scranton said he feels her message came across as far more hopeful than assured.

“Personally, I agree with those who’ve said that our economy is still too vulnerable to negative global influences to justify even this small rate hike, and that trailing indicators like inflation and job growth are still too soft,” Scranton said. “But I think Janet Yellen also felt that raising rates slightly now would at least give her some wiggle room if we should head into another recession. And if you look at some of the leading indicators like new housing starts and the Purchasing Mangers Index, one could argue we’ve already turned that corner.”

Given all these factors, Scranton told clients that what concerns him most is the potential impact on the stock market if the Fed should be forced to reverse the rate hike later in the coming year. He pointed out this isn’t uncommon, and has happened with central banks in Europe, Australia and several Scandinavian nations.

“If Wall Street saw this rate hike as a vote of confidence in our economic future, would it see reversing it as a vote of no confidence?” he said. “That’s something investors should think about, especially if they’re anywhere near retirement. History suggests we’re long overdue for a major market drop of between 25 and 65 percent. There are a lot of shaky situations around the globe that could serve as a tipping point, and the Fed may have inadvertently just given us another one.”

With over 25-years of experience in the financial services industry, David J. Scranton (CLU, ChFC, CFP®, CFA, MSFS) is a highly sought-after market expert who frequently shares his insights on CNBC, Fox Business and other outlets. In addition to running his own advisory practice, Scranton Financial Group in Connecticut, Scranton is founder of New York-based Sound Income Strategies, a Registered Investment Advisory firm specializing in the active management of individual fixed-income securities. Scranton is also founder of Florida-based Advisors’ Academy, a prestigious training and marketing organization for elite financial advisors nationwide who specialize in helping clients create “defensive,” income-generating savings and investment plans. Scranton adopted his unique business model after his research into market history enabled him to forecast—and protect some clients from—the 2000-2003 market crash. Scranton is author of the acclaimed book “Stop the Financial Insanity,” which details his eye-opening research into stock market history.

Securities offered through Sound Income Strategies, LLC, a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor or tax professional about your specific financial situation before implementing any strategy discussed herein.

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