Tariffs Could Blow Up the Bond Market | Mark Zandi on the Biggest Risk to the Economy
Jan 28, 2025
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Mark Zandi, Chief Economist for Moody’s Analytics, shares keen insights on the US economy. He highlights how broad-based tariffs could drive up bond yields, posing a significant risk to economic stability. Zandi discusses the elevated recession risk, driven by policy uncertainty, and delves into the roles of Fannie Mae and Freddie Mac, cautioning that exiting conservatorship could hurt the mortgage market. He also provides a nuanced view of inflation dynamics, emphasizing the complex interplay of labor supply and consumer debt.
Mark Zandi highlights that broad-based tariffs could significantly elevate inflation, posing a major risk to the bond market and the economy.
Despite a strong economy with low unemployment and stable inflation, Zandi foresees recession risks primarily due to policy uncertainty and potential tariff implementations.
The discussion on Fannie Mae and Freddie Mac emphasizes the complexities of their exit from conservatorship and its potential impact on the mortgage market.
Deep dives
U.S. Economic Strength and Growth Expectations
The U.S. economy is currently experiencing exceptional strength, with GDP growth anticipated to be around 3% for the fourth quarter and for 2024 as well. Job creation remains robust, averaging about 150,000 jobs per month, keeping unemployment low across various demographics. Inflation has also stabilized close to the Federal Reserve's target, interrupted by past issues but now appearing contained. Stock markets and housing values have reached record highs, suggesting a healthy economic environment and acknowledging the Federal Reserve's success in achieving a soft landing.
Risks Posed by the Bond Market
Concerns about the bond market have been emphasized, particularly in light of potential economic policies from the incoming administration that may include increased tariffs and restrictive immigration policies. Such policies could lead to higher inflation, which negatively impacts bond investors as inflation diminishes the value of fixed returns. Bond yields have already risen substantially since last September, coinciding with increased support for certain economic candidates. The fundamentals behind these bond market trends raise alarms about the possibility of persistent inflation, which could put further pressure on the economy.
Impact of Rising Treasury Yields
Currently, the 10-year Treasury yield is hovering around 4.6%, with fears that if it surpasses the 5% mark, financial markets could face significant corrections. Rising interest rates tend to exert downward pressure on asset valuations, including stocks and real estate, which in turn could dampen consumer spending driven by wealth effects. If stock prices and housing values were to decline, there could be repercussions for the broader economy, especially as many consumers currently depend on high asset values for their spending behavior. Despite these concerns, it is believed that the economy can tolerate rates up to 4.6% without significant disruptions.
The Uncertainty of Tariff Impacts
Broad-based tariffs have historically been viewed as detrimental to economic growth and inflation, as they act as a negative supply shock. Such tariffs can complicate monetary policy decisions for the Federal Reserve, leaving them unsure whether to raise rates in response to inflation or lower them to support economic growth. The uncertainty surrounding possible tariffs has prompted caution within the Federal Reserve, which could impact their immediate policy decisions. Experiences from previous tariff implementations reveal their potential to cause substantial disruptions across various sectors like agriculture and manufacturing.
The Future of Fannie Mae and Freddie Mac
The discussion surrounding Fannie Mae and Freddie Mac touches on their current conservatorship and the implications of potentially releasing them back into the private sector. While some argue for a market release to benefit taxpayers, concerns persist regarding whether this would genuinely improve the mortgage system or merely complicate it without an explicit government guarantee. The status of these entities post-release remains uncertain, particularly in relation to their ability to function effectively in financial markets. It's crucial to consider that any changes made should not negatively impact the current functioning of the mortgage finance system, which has been functioning relatively well under the existing conservatorship.
Mark Zandi, Chief Economist for Moody’s Analytics, joins monetary matters to discuss his outlook for the US economy and why he thinks higher yields driven by broad based tariffs are the biggest risk to the US economy. Despite the economic strength he still sees he believes recession risk is elevated, and this risk is being driven primarily by policy uncertainty. He also discusses the GSEs, Fannie Mae and Freddie Mac, and why he thinks most paths to exiting conservatorship create a lot of pain for the mortgage market.
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