Tariffs Could Blow Up the Bond Market | Mark Zandi on the Biggest Risk to the Economy
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The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough. Thank you. Let's close this door. Very pleased to be joined by Mark Zandi, chief economist at Moody's Analytics. Mark, it's great to see you. Welcome to Monetary Matters. Thanks, Jack. It's good to be with you. Thanks for the opportunity.

I'm really glad you're here, Mark. You have been a cheerleader for the U.S. economy, defying calls that the U.S. economy would enter a recession. And so far, the economy has been very strong. Just how strong do you think the U.S. economy is? And do you think the Federal Reserve has achieved the fated soft landing? It's strong. I mean, I'd say exceptionally strong. A lot of growth. GDP is

Uh, we'll come in in the fourth quarter around 3%. And that'll be the growth rate for the year 2024. That's strong growth, lots of jobs, uh, average monthly job growth feels like it's around 150 K that's right down the strike zone enough to keep unemployment low. The unemployment rate is low 4% ish. It's low across every demographic. Um, inflation, which had been the problem is kind of back in the bottle, uh, very close to the feds target. Um,

Stock market's at a record high, close to housing values have never been higher. So, yeah, I think the economy is doing very well. And, you know, I think at this point I'd give Fed credit for soft landing the economy. Yeah. I mean, certainly something could derail it, but it's easing interest rates, lowering rates. And I think it's fair to say that the economy has soft landed. They achieved what they had hoped to do.

And what do you perceive as major threats to the U.S. economy? You've got a piece out recently called All Eyes on the Bond Market. Why are you concerned on the bond market? A bunch of reasons. I think this fundamentally goes to economic policy. I mean, the incoming administration or the new administration is going to pursue economic

In one form or another, more tariffs, more restrictive immigration policy, perhaps a lot more deportations. We're going to get some tax cuts. Not clear how much of that's going to be deficit financed. President Trump has talked about his view that the president should have input into the Federal Reserve's conduct of monetary policy.

All these things directionally point to higher inflation. And of course, nothing is inflation is the kryptonite for the bond market. Bond investors don't want inflation. And so I think the most fundamentally, the bond market is at risk as a result. And of course, bond yields have pushed up quite a bit since really go back to last September, about the time President Trump started winning consistently in the polls and the betting markets.

Rates have gone much higher, about a full percentage point higher today than back in mid-September. And I think that lots of reasons, but I think the most fundamental and perhaps most significant is worries, concerns about economic policy and what it means for inflation.

What do you think are the consequences of a high U.S. treasury yield? I think the 10-year is around 4.6% or 4.7%. What's the impact going to be on financial markets as well as the economy? Asset prices are very high. Stock market, as I mentioned, is at a record high. Crypto prices have never been higher. Bitcoin is well over $100K. Housing values are at a record high.

gold. I mean, everything's up a lot and valuations are high. And when rates, interest rates move north, that puts pressure on valuations. And that, I think, puts these asset markets at risk of a correction, a decline in price if interest rates continue to rise. And that has consequences for the real economy. I do think

The U.S. economy is very dependent on very well-to-do consumers. A lot of the spending being done is being done by folks in the top part of the income and wealth distribution. They're spending in significant part because they're wealthier. They are wealthy, they feel wealthy, and they're saving less and spending more. But that all goes away if stock prices and housing values come under pressure. And so

The run-up in interest rates, if it continues, I mean, I think the economy can digest a 4.6% 10-year treasury yield. If we get back closer to 5% or north of 5%, that's the risk. I mean, my baseline is that's not going to happen. I think long-term interest rates will peak roughly at where they are and kind of settle in somewhere 4.25%, 4.5%.

But I do fear that if I'm wrong, I'm wrong because bond yields are higher and that will have implications for asset prices, the stock market, and ultimately the real economy.

And Mark, when the 10-year was not at 4.6%, but at 1.6%, or even close to 1%, or even below 1%, people would say, oh, the 10-year at 2% will break the economy. The 10-year at 2.5% will break the economy. And yes, as the yields surged in 2022, the stock market definitely had its challenges for sure. But I think that the economy and

in the long term, the stock market has done very well as the 10-year yield has shot up. So what is going to the same people who said the market can't handle 3%, it's handled 3%, it's handled 4%, it's handled 4.6%. Why do you think it can't handle 5%? Why can't it handle 6%? And I think probably 98% of people, when they say the market can't handle this level, they're really just making it up. I'd count you among a few people who really have done mathematical models to try and find

This really is the breaking point at which things start to reverse. So why is it that when you did a model for Moody's Analytics, you found that it would take the 10-year being at 7% for multiple quarters for real GDP to actually decline in consecutive quarters and for there to be a recession? It depends on context, right? I mean, if the reason why the 10-year yield is rising is because of growth, then

No problem. The stock market's fine. Both can rise in tandem. But if the bond yields are rising because of inflation, that's a different story. And that makes the stock market and valuations at risk.

My sense is that the bulk of the increase in rates has nothing to do with increased expectations of increased growth. It has more to do with expectations for higher inflation. You can see that in inflation expectations, different measures coming out of the bond market. And, you know, the term premium is widened related to inflation uncertainty. There's a lot of uncertainty around inflation and the volatility of

is causing the so-called term premium difference between long rates and short rates to widen, and that's pushing up long rates. So it really depends on why the 10-year yield is rising in terms of its implications for the equity market and the broader economy. And that's built into the model you mentioned. We have a model of the U.S. and global economies that we use for lots of different purposes.

One of which is to kind of do what if scenarios, what if oil prices spike? What if the Federal Reserve jacks up interest rates? What if the stock market declines? And I did a what if, if 10 year treasury yields, all else being equal, rose from where they are now 4.6%. And what I did was kind of a reverse kind of stress test. I said, well, what kind of interest rate would it take to actually push the economy into recession according to our model?

I defined recession as two quarters of consecutive negative GDP growth. As you know, that's not the official arbiter of recession, but that's a good proxy historically. And I found that roughly, obviously I'm rounding, but if the 10-year yield goes up because of worries about inflation to its highest and deficits and debt go to this high 7% and remain there for two quarters,

that would be sufficient to push GDP negative for two consecutive quarters and thus recession. So that's the exercise that I performed just to give our clients and others a sense of how high rates have to go to kind of break the economy. One other quick point and then I'll stop. These models that we're using, they're very, there's not some, what I'd call non-linearity in the models, but they are very linear, right? These are

The world is a very nonlinear place. So the reality is, depending again on circumstance and context, what's driving the higher 10-year yields, you may not need the 7% 10-year yield for two quarters to get into a recession. It could be something much less than that, depending again on circumstance. Talking about nonlinearity, in your model, does it factor in currencies and the level of the dollar? Because I imagine if the 10-year is at 7%,

that would probably strengthen the dollar because Japanese and European investors, everyone around the world would say, "Hey, 10 year at 7% is a pretty good deal." And that could weaken the economy because it could hurt US manufacturing as well as foreign markets. So that question about foreign exchange in your model, but also just the dollar is quite strong right now. Is that a concern to you? David Collum : I think that the strong dollar is a reflection of concerns

Well, it's a bunch of, again, a bunch of reasons. One reason that's more benign is the U.S. economy is stronger than every other economy on the planet, right? So it attracts a lot of capital, keeps the dollar up. It also keeps the Federal Reserve from

lowering rates further, it feels like they're now on pause. Other central banks are easing policy like European Central Bank, the Bank of Canada, the Bank of England. The exception would be the Bank of Japan. They're always on a different wavelength altogether, and they still are. So those are key reasons for the strong dollar that are less worrisome. But the dollar probably is also up in anticipation of tariffs.

You know, tariffs mean that it's going to be very hard on particularly emerging market economies, the Chinese economy, and those currencies are weakening in value and the dollar is appreciating. If that's the reason why, that is somewhat concerning, right? Because a strong dollar is already hurting exports and economic growth, making it more difficult for U.S. manufacturers that export their product to the rest of the world. So, yeah, I think the dollar...

should be watched very carefully here. And I do think if we get into much higher tariffs in a trade war, President Trump is starting to raise, does actually raise tariffs in a broad-based way, other countries will retaliate.

One of the ways they may retaliate is work to weaken their currencies, like the Chinese, for example, may work to lower their currency to offset the effects of the higher tariffs, in addition to doing a lot of other stuff to respond to what President Trump has in mind. So, yeah, the strong dollar part of it, no worries at all. It should be strong. It should be high, I should say.

Probably a better way to say it. But part of it is for reasons that are downright worrisome, the potential for a trade war.

How do high tariffs or trade war, how does that impact the economy, unemployment, inflation, GDP? Tell us what the standard models say that's been the orthodoxy over the past, let's say, 40 years. Tell us what the Trump-aligned economists who are in support of tariffs and in support of the pandemic,

political movement to, you know, have perceived perceived cheaters at trade be, you know, a restoration to a fair balance. And then tell us what you think. I think this is pretty settled economics. I mean, you know, we debate everything, but the debate here is

been settled 100 years ago. Tariffs are a bad idea, broad-based tariffs. I mean, if they're strategic, small, with a real clear point you're trying to make to a trading partner for some reason, I get it. No big deal. But broad-based tariffs across lots of products and countries over an extended period is just a really bad idea. It's what economists call a negative supply shock, meaning it raises inflation.

and therefore interest rates, rates will rise, and it diminishes growth. And it complicates things enormously for the Federal Reserve. What do they do? Do they

raise rates to combat the high inflation or do they lower rates to support the economy, the weakened economy? And the answer is they don't know. And that's why the Fed has gone on hold here because they don't know. They know they're worried that tariffs are coming and we're going to have this negative supply shock. They don't know. But to what degree, how extensive are the tariffs going to be? Is this more negotiating? Is this just politicking? You know exactly what's going on because they don't know they're doing

exactly what you'd expect. They're just sitting on their hands now and not moving until they get some clarity until the dust settles. So tariffs are a bad idea. Broad-based tariffs are a really bad idea. It's a tax on the American consumer. It leads to retaliation. It hurts American manufacturers. Just go back to the tariffs imposed under President Trump's first term.

They were kind of modest. It was $300 billion in imported product from China faced higher tariffs. So for context, we import, what, $3.5 trillion a year or something like that. So it's relatively modest. And that did real damage. Go back to late, kind of into 2019.

The nation's agricultural industry farmers were in recession. President Trump had to cut checks to the farmers to compensate for the fallout from the trade war with China. They stopped buying American agricultural products. They retaliated. U.S. manufacturing was flat on its back. It was headed towards recession. And in fact, you know, by the end of 2019, President Trump was backtracking on the tariffs, declaring victory, of course, that he had

got the Chinese to do what he wanted them to do, and it was starting to pull back on the terrorists. And of course, then the pandemic came, and we went on to other things, much more important. So recent history shows exactly what's going to happen if we have broad-based terrorists. I think it's just bad policy.

You'll have to ask the Trump folks, you know, what their logic is. I mean, I'm not sure, really. I don't get it. You know, some conversation around, well, maybe the tariffs lead can the effects on the American consumer can be mitigated by the higher value of the dollar, which is true. But that doesn't consider the ill effect of the higher dollar on American producers on the manufacturing base, which is presumably exactly the same.

what President Trump said he, the sector of the economy he wants to support. So I don't get it. And it doesn't account for what clearly will be retaliation. I can't, I just, again, go back to the tariffs under Trump, President Trump's first term, every other country's retaliated and they're going to do, particularly the Chinese,

And they're going to do the same thing, tit for tat, as they say. And so, again, it does a lot of damage. So I'm confused by it. You'll have to ask them exactly what they're thinking. So in your worldview, and let's be honest, in the worldview of many economists, say consensus or near consensus, tariffs are inflationary and bad for people.

economic growth. For a lot of human history, like a lot of the 19th century or 18th century, there were tariffs and the sun still rose. But I guess the idea is to restore imbalances. And I think there is a big imbalance between the US and China. China has a trillion dollar trade surplus. And that's a lot. And they should be strengthening the yuan because the

The U.S. is having a huge deficit. China has a huge surplus, so the yuan should strengthen. And that makes Chinese manufacturers less competitive. But the yuan hasn't really strengthened a whole lot. So maybe is China kind of keeping yuan too low in order to stimulate industry as well as giving...

industrial companies close to zero interest rate loans to stimulate the economy to quote unquote dump things in the rest of the world? Do you agree that there's a fundamental imbalance that

should be restored, should be returned to equilibrium. And that's what terrorists are trying to address. You just don't think the right way to get there at all. I don't think the Chinese play fair on lots of different levels. It goes beyond trade. It goes to cyber. It goes to intellectual property rights. It goes to

foreign direct investment, the ability to invest in Chinese companies. It goes to lots of different things. So I think it is reasonable and fair to address that. If I were king for the day back in the day, 10 years ago, I think the strategy of entering into the Trans-Pacific Partnership was the right strategy. That's a free trade deal with the US and all of the Pacific Rim nations that excluded China because they didn't play fair. That never was implemented. That was the

Probably the first executive order, the second one that President Trump implemented in his first term killed it. In my view, a mistake, but okay, so be it. I agree we should be focused on trying to address those imbalances.

I just don't think tariffs work and you're taking it out on the American consumer and American companies. It's like, you know, flogging yourself to try to hurt the other guy. I mean, really? I mean, it makes no sense. And by the way, it doesn't, it doesn't, it's very, it makes it very difficult to work. I mean, what the Chinese have done in response to the first round of trade tariffs is just divert trade. I mean, you know, they moved into Southeast Asia, they moved into Mexico and their trade

properly measured deficit with the surplus of the U.S. has not changed. It has not budged even despite those higher tariffs. They're still in place today.

So, and then of course, you could take the view that while on post-terrorists on Mexico and Vietnam and all those other countries, but then you're doing more damage there. And by the way, because of all of the trade diversion, the supply chains have gotten a lot longer and more complex, less resilient. And that's definitely, you're just adding to cost. And that's the other aspect of tariffs I think people forget about and is probably most importantly long run

is they're very capricious. Tariffs on exactly which countries, which products, over which period of time. I don't know if you've taken a look at the tariff list. It's incredibly mind-numbing, all the different products and what their tariff schedules are.

And then businesses, and certainly in the case in President Trump's first term, they could petition the administration and say, hey, look, this is unfair. I'm returning my business. It's harming national security. Can you give me an exemption or some kind of break here? And they would, but that was a very opaque, non-transparent process. So you don't even exactly know who's getting the break and for what and over what period of time. So that just adds to cost. It creates uncertainty. It adds to cost. So

I understand the need to address our relationship with China. It's just the tariffs aren't the way to do it. They didn't work in President Trump's first term. I don't know why you'd think it'd work in the second term, second round of tariffs. And in second term, I just don't see it.

So you don't think tariffs are a good idea at all? Broad-based tariffs. Broad-based tariffs. Thank you. You've got a chart showing various potential scenarios, like a 20% universal tariff, a 60% tariff on China, 200% tariff on Mexico, and you've got various scenarios. If those kind of nuclear-level tariffs are reached, what would be the consequences across what parts of the economy, what asset classes, and how dire do you think it would be?

I don't think President Trump is going to go down those darkest paths. That's just for didactic purposes to kind of illustrate, you know, how some of these proposals would, under the most extreme kind of scenarios, would be very difficult for the economy to digest, given that the Chinese will respond in kind.

it'll be highly disruptive and recession seems like a real possibility. Obviously, those industries that are on the front lines here that do a lot of trade will be nailed badly. Manufacturing, transportation distribution, agriculture, maybe the energy sector and mining. I mean, you can hear the Canadians talking about export tariffs on energy into the U.S. as a way to respond to American tariffs on the goods that the

that are imported from Canada. It's not hard to get to a very, very dark scenario where lots of industries are under a lot of pressure. I don't think any asset class that relies on growth would navigate through this gracefully. It would be a pretty painful period. And I should also point out, this is a bit of a stretch, but something to consider.

I do think it raises geopolitical tensions and raises the possibility of something happening outside of just pure economics. I mean, political, military, whatever. And of course, if that were to happen, then that would be incredibly disruptive to the global economy, our economy, and to all financial markets as well as ours. How are you assessing the probabilities of how this works?

tariff scenario will go over. Let's say the first six months of the Trump presidency. Paul Jay Jack, that's a difficult one. I don't know. And that's the problem. No one knows. So the uncertainty is palpable. I guess we'll get a sense of it here pretty soon, right? The president's been talking about, was it yesterday he announced a 10% tariff on Chinese goods that are already on top of the tariffs that are already in place.

beginning on February 1. Let's see what he does with that. He's talked about 25% tariffs on Canada and Mexico. I don't think he's been more explicit than that. Not that I've heard. But let's see what he does by March the 1st, did he say? I can't quite remember. Let's just see how much of it

this talk, how much of it is a real decision to go down the tariff path. I don't know. And that's what the Federal Reserve said. If you go look at the minutes of the December meeting as I mentioned earlier, the number of members said we've got to stop cutting rates until we have clarity around these policies because they didn't know, nobody knows. And to some degree, President Trump may not know. Maybe his negotiating stance for something, I don't know what.

As such, he doesn't even know exactly where he's going to go with these things, at least not at this point in time. How much of the Federal Reserve decision to go slow on cutting interest rates and kind of take a pause in cutting interest rates is due to that geopolitical uncertainty of, yeah, if there are huge tariffs, then that CPI and the PCE will go way up. So the neutral rate of interest will go up if there's a 200% tariff on Mexico, of course.

I think they said it. It's in the minutes. I think it's part of it. I don't think it's the only reason. I mean, the economy is strong, so they may be asking themselves appropriately, so what is the so-called equilibrium rate, that rate at which policy interest rates are neither supporting or restraining growth?

it maybe is higher than it has been historically at this point in time. It's not written in stone and it will ultimately fall back. But right now, for various reasons, it may be elevated. So we don't need to lower rates much from where we are. We're fine where we are. So that may be entering into their calculation as well. And inflation has been a bit sticky compared to their target. It's hovering just over the 2%. I think

It's mostly about measurement around housing costs, but they may take a different view that we're not actually there, and another reason why they might not continue to cut interest rates at this point in time. So I think there's other factors involved, but I do think the uncertainty around economic policy, tariffs, immigration policy, taxes, deficit finance, all of that is going to be a problem.

All those things are entering into their thinking that, hey, let's just sit on our hands here, not cut rates until the dust settles a bit. We get some clarity around economic policy because at the end of the day, part of their job is is calibrating monetary policy to to respond to what fiscal policy lawmakers are doing. And if they don't know what they're going to do, then they can't adjust monetary policy appropriately. So it makes sense for them to pause.

Core inflation is roughly just below 3%, 2.7%, 2.8%. Why do you think it's taking so long for it to return to 2%? What are the holdups? And what do you think it's going to take to get to that 2% bogey, which is the Federal Reserve's target? Talk both about shelter, which is a huge component, of course, but also what the Federal Reserve, I think last meeting referred to as non-market inputs, such as

healthcare, maybe insurance. I mean, the weightings of CPIs and PCE inflation baskets is so interesting to me. There's so many nuances that I think someone like me and probably a lot of people watching who aren't going through the index, they're not seeing all the different constituents and how it could play out. I think the biggest reason for the gap between current inflation and the Fed's target is the growth and the cost of housing services. And it's just measurement.

Ultimately, the cost of housing services is tied back to rents. And the way the Bureau of Labor Statistics, the BEA, calculates these indices, there are long lags. It takes a long time for shifts in rents to translate through into these price measures. And there was also something very idiosyncratic in the post-pandemic period where

Coming out of the shutdowns, you saw the surge in demand as households formed for rental units and supply was very constrained because of the supply chain issues and the labor market issues. So you had this situation where rents jumped for folks that were newly renting 20, 25 percent. Landlords didn't want to raise rents 20, 25 percent for existing renters. That would be terrible.

Very difficult for those renters to digest. So they've been raising them strongly, but at 5% increments. So it's taken some time for those rents to catch up to the market rents that they're charging new renters. And so that attenuated the lag between rents and when it showed up in the price measures.

But it is now. If you look at the most recent months, you can see the growth in the cost of housing services is growing much more slowly. And if we don't have tariffs, if we don't have deportation and more restrictive immigration, all that kind of stuff, I suspect we'd be back fully at the Fed's target by this spring, early summer. But we may actually not get there depending on

the tariffs are, when they're implemented, and so forth and so on. So we may be coming right into that 2% and it's within spitting distance. And then we start taking off again because of the higher tariffs. But we'll have to see. What are the economic consequences of deportations? There's always deportation. So in its typical levels of deportation, probably 250,000, 300,000, 350,000 per annum.

So if that's what we're talking about, no big deal. But President Trump seems to have something else in mind. If it's five, six, seven hundred, eight hundred thousand deportations, which also means there's probably self-deportation because you're scaring the heebie-jeebies out of immigrants here and they're going to go. And also employers may not hire people that they that are questionable at all. They don't want to take the risk.

And so you'd see significant movement of people out. And a lot of the immigrants that have come into the country, particularly the last few years in the surge across the southern border, most of them actually went to work. They got work authorization. They went to work and had juiced up the labor supply. It was quite fortuitous in that it took pressure off labor markets at the time when the Fed was trying to cool things off in the labor market. So it was kind of worked out.

obviously the surge created all kinds of costs and other problems for communities across the country. But the one benefit was that it generated a lot of labor supply. So if you go in the other direction and you require people to leave, then, um,

You're going to cause these labor markets to tighten up. Wage pressures may manifest again, put upward pressure on prices and help to stoke inflationary pressures. And immigrants are very important to certain sectors of the economy that are key to inflation. So, for example, almost 30% of all the workers in the construction trades are immigrants. About half of those folks are undocumented or unauthorized and therefore at significant risk of deportation.

Of course, we just talked about the growth in the cost of housing services as being a problem for overall inflation. And that goes to demand and supply. And if you kick out a lot of construction workers and they don't build, that's less supply. That just jacks up rents and prices and the cost of housing services.

picks up again and inflation is a problem. And this issue with regard to immigrant workers in the construction trades is most prevalent in the South and the West. And those are the areas where immigrant workers are more prevalent in the construction trades. And of course, that's where the housing shortages are particularly severe. So you're just exacerbating those. That's just an example. The other area where inflation has been a real problem for people is groceries, food. And

the second industry with the second most immigrant workers is agriculture. And so you're just going to exacerbate

The labor shortages on the farms and in the fields add to costs and add to potential inflation. So housing and groceries, the two things that people are most upset about, their rent and their grocery bill, that policy will create problems for those industries, labor shortages, higher wages, higher costs, higher prices.

You said that the elevated levels of immigration over the past, let's say, five years has eased labor conditions because it has increased the supply of labor. So there's slightly less wage pressure. More people are working and consuming. How much of that is documented versus undocumented immigrants, as well as tell me who goes into the statistics I'm about to tell you.

The jobs number, non-farm payrolls from the establishment report, unemployment rate from the household survey. To what extent are undocumented immigrants captured in those numbers? And I guess I'm asking you to share your thoughts on the idea that the jobs number is artificially inflated by the level of immigrants or unemployment rate is also somewhat affected because of measurements.

There's a lot to chew on there. The payroll survey, the survey of businesses, which is the basis for the employment numbers that most of us look at when we're trying to gauge employment growth.

That would pick up immigrant workers. So I am an immigrant. I come here looking for asylum. You're brought into the country. You're given a court date, but you're allowed to apply for work, get authorization to work. You apply for work. And then I think it's nine, 12 months later, generally, you get that authorization and you're off and running and you can get a job.

And so many, most of the immigrants that came over the past several years across the southern border seeking asylum, they ended up there. They're in the payroll numbers are working. They got a job and they came at a time when businesses needed those workers. There was severe labor shortage, the unemployment rate.

If you go back a little year ago, it was 3.5% headed south. That's when the Fed was jacking up rates to try to cool things off, weaken demand. Fortunately, they didn't have to do that because they got all the labor supply, and that allowed them to forestall even higher rate increases. And that's one reason why the U.S. economy was able to avoid an economic downturn or recession. The household survey up to this point in time has not reflected the immigration surge.

because it's based on population counts that come from the census. Now, the census just recently revised its population estimates. So that's going to be brought into the household survey numbers, I think, within the next month. The census doesn't go back and revise the historical data, though. So you're going to see this discrete jump in the January data showing all the people that are now counting, the immigrants that they're now counting.

none of this affects the unemployment rate because this, in our first order, because it affects both the numerator and the denominator and therefore won't affect to a significant degree the overall unemployment rate. Now, it may second order or third order because unemployment for immigrants may be a little bit higher than for native-born workers and therefore if you make this change, the unemployment rate might push up a little bit. So when we get the next

employment report, if you told me the unemployment rate is 4.3, 4.4, that sounds about right to me. It could go up a little bit as a result.

But that's more second order, not the third order. So the statistics are particularly payroll survey is dead on accurate. It's telling you exactly because that's based on ultimately based on unemployment insurance records. So you could argue and this is fourth order or fifth order that maybe there's some bias in the unemployment insurance records.

because this takes time for immigrants to get into the unemployment insurance system and so forth and so on. And so you might see some revision there over time, but I think that's, again, fourth order, fifth order of facts. So you actually think that nonfarm payroll data is of a higher quality and fidelity than the unemployment rate. So you think the nonfarm payroll, which is a statistical assumption, they're not talking to the over 300 million people, it's impossible to do. You think that's reasonably accurate?

Yeah, and I think the unemployment rate is reasonably accurate, too. It's the household employment or the labor force from the household's rate that's not accurate, that will be revised or not revised, but we'll see this big discrete jump once the

Bureau of Labor Statistics incorporate the new population counts that now account for the immigration surge. It didn't previously, now does. So you're going to see this big jump in household employment and labor force. The reason why it's a jump is because Bureau of Labor Statistics does not go back and revise history. It is what it is. And they just go forward. But when you take a ratio of two things, like the unemployment ratio of the number of unemployed divided by the labor force,

That is less impacted by these because they both, the numerator and the denominator, are both biased by this same phenomenon. Again, with that caveat that, you know, you may see a little bit of an uptick because if you're adding a lot of immigrant workers, they may have a somewhat higher unemployment rate than native workers. And so that might push it up a little bit.

How are you thinking about the levels of US debt? You've got several charts and figures on both the liquidity in the bond market, but also sovereign credit default swap spreads have gone up, which theoretically the US could default on its debt if it makes a political mistake. How are you thinking about that, as well as the level of debt under Trump?

Well, this goes back to where we started with regard to bond yields. Another reason is debt levels are high. I mean, debt is 100% of GDP and all the trend lines here look pretty bad. Even if the TCGA Tax Cut and Job Act tax cuts for individuals, which are set to expire at the end of 2025, actually did expire, our deficit and debt would continue to remain high and continue to rise.

But of course, we're not going to do that. The Trump administration is going to extend all those individual tax cuts. So it's going to be even worse than what the CBO is now projecting under current law. The other thing I think even more important, perhaps, is to focus on the interest expense on the federal debt, compare that to GDP or revenues.

That's taking off for lots of different reasons. Interest rates are up and debt has become more short term. And so we're going to pay more in interest expense as a nation than on our own defense in 2025. It's going to be over a trillion dollars and we're headed straight north. And those things are worrisome. And I do think you combine that with

All the issues around governance, how politically dysfunctional everything is. We have a hard time passing a budget to keep the government open for any extended period of time. We've got the debt limit battle again. One might have thought now that

Congress and the presidency is under Republican control, that wouldn't be an issue. But I'm not so sure because the margin, the Republican margin in both the Senate and House are very thin, particularly in the House. And you've got a group of Republican congresspeople that swore a blood oath that they were not going to raise the debt limit unless you got significant cuts in government spending, which is going to be really hard to do.

And interestingly enough, you look at, and I'm not the only one who's nervous, you look at investors' views through the CDS market, the credit default swap market. The CDS market is basically you're an investor, you can buy insurance for the case where the treasury defaults on the debt or doesn't pay the debt on time to compensate for that risk. I can go buy insurance, and the credit default swap is a measure of the cost of that insurance.

If you go look at it, it rose very considerably after the 2023 debt limit battle, which is what you expected. But it's remained very elevated since then, as investors are still very nervous about the next debt limit battle. I think everyone feels like at the end of the day, lawmakers will get it done and pass it, but maybe they make a mistake intentionally or unintentionally. And so I think there's angst around that and nervousness.

I think we're a rich nation. We're the reserve currency, so it buys us a lot of latitude. We can make all kinds of mistakes and just be real screw-ups and still be okay. But I do think we're testing the bounds here, and I am worried. I am nervous that at some point,

Bond investors are going to say, you know, no mas. You know, you're going to have to pay me a lot higher interest rate to compensate for the risk that I'm bearing here to take on your debt.

Theoretically, bondholders have been doing that over the past four months because you say that the term premium has been widening significantly. Do you think that will continue to widen and that the 10-year will go to 5%, 5.5% or even higher? That's not my most likely scenario in the middle of the distribution of possible outcomes. I think not.

I say that with no confidence, though. And as we were discussing earlier, the number one threat in my mind is I'm wrong about this and that we do see bond yields rise more than I think. Five percent, we blow through five percent. And if that's the case, then the economy becomes diminished. And as we discussed earlier, if we get to seven percent for an extended period of time on the 10-year treasury yield,

We're toast. We could go into recession again. That's that's a scenario. I worry about it. I think it's my at this point, my number one threat to any optimism. But it's not my baseline. I think we should be able to navigate through, you know, at the end of the day, government is under Republican control. OK, come on. Yeah.

You would think if that's the case, you can figure this out. I know it's not easy. There's a lot of moving parts. So the logic would dictate that the lawmakers will be able to get it together before they do any damage. Selling U.S. Treasury default risks sounds somewhat attractive to me. Unfortunately, I'm not deemed a creditworthy counterpart. But yeah, what can dream? I'm sure you're not too far away. Just stick with it. I'm sure you'll be accredited pretty soon. Mark, you've been...

correct that the recession would not happen. How are you handicapping recession risk right now? Or would you say recession risk is lower than normal? Would you say it's normal recession risk, which is what, 1 in 7, 1 in 10, you tell me, or an elevated recession risk? I think they're elevated. I think typically, unconditional probability of recession is like 15%. What's that? 1 in 6, 1 in 7, something like that.

If I had to give you a number, I'd say 25% probability of a recession starting at some point in the next year. So I guess low, but I guess uncomfortably high. 25%, you know, one in four,

It depends on which side of the coin you want to look at it from. And it shouldn't be that way because the economy is in a pretty darn good place, right? I mean, we talked about it at the top. It's performing exceptionally well fundamentally in a really good place. So for the probability of recession to be that high, that's just disconcerting. And it goes to policy. It goes to economic policy and the uncertainty around the policy.

So Mark, you think that the risk of recession is elevated because of policy. I might offer another reason, curious to get your thoughts on it, which is rising consumer debt levels. So consumer household debt levels have actually been low. And in 2021, they were extraordinarily low. But a lot of the spending since 2021, which has been enormous, the consumer spending has been enormous, has been financed with debt. Credit cards, other revolving credit, I think it's called,

Well, at what level do you think that starts to become an issue? I know the delinquency rate on credit cards is somewhere, you know, the highest it's been since 2011, which is, you know, pretty significant.

I would push back on that. I don't think the spending has been fueled by a significant... There has been a significant increase in debt among low-income households back when inflation was raging and outpacing wage growth, 21, 22, 23.

Low-income households did turn to their cards to supplement their income. Consumer finance loans buy now, pay later. But that's small in the grand scheme of things. I'll give you a statistic. The folks in the top third of the distribution account for 55% of spending in a typical time. Right now, it's probably higher than that, but in a typical time. The folks in the middle third, they account for a pro-rata share of spending a third. Folks in the bottom third account for 15%. And that's where the debt level, debt has risen.

And if you look at the actual dollar amounts, it's really quite modest, very, very small. Now, for those folks in the bottom third of the distribution, this has been a real problem, no doubt about it. They...

In part because of the borrowing, but in part because of interest rates. I mean, they started borrowing back in 21 and 22 when rates were low. Now they're high. The average rate on a credit card is 23.5%, 24%. Can you imagine that? 24% on credit card debt. That's usurious. And so very, very difficult on those folks. And you did see delinquency rise quite significantly. Yeah.

We get all the credit files in the country every month. So I see the whole census of all the credit outstanding. And the delinquency rate on credit cards peaked at just about 4% in this last summer. And, you know, that's not financial crisis high, but that's higher than it was, you know, at the peak prior to the pandemic. So that shows stress.

The good news, though, is, again, this is just a part of the economy where spending is relatively modest. And also because of a tightening in underwriting standards and because inflation is back in and borrowing has moderated, delinquency rates are falling again. So the delinquency rate on credit cards, on consumer finance loans.

on auto loans are falling. They're coming in. Not fast, but they're coming in. They're lower today than when they peaked back in the summer. So I think there has been some significant financial stress, mostly among very low-income households. It hasn't been a macroeconomic problem because they only account for a small share of overall spending.

And even for those folks, things are getting better. We've kind of turned the corner on those issues. So I'm not concerned about that at all. No.

I appreciate your strongly held view. And yeah, I'll say just from the banks that have reported earnings so far, I've seen in year-over-year delinquency statistics, it is roughly in line with what you're saying. And obviously, you have access to way more data. That delinquencies may have peaked. I'll use the word may. Mark, let's now turn to a topic where you are a huge wonk on, the

It's not a topic that you'll read on the front page of The New York Times, but it is incredibly important and it impacts people in a very powerful way. I'm talking about Fannie Mae and Freddie Mac, GSEs, government-sponsored entities, which were private and then they were taken over by the government in 2008. They securitize businesses.

the mortgage market. And they basically are the reason why in the U.S. people can borrow out a 30 year mortgage that they can prepay, which it is a privilege that a lot of the rest of the world does not have. Since 2008, they have been in conservatorship. Basically, they've been controlled by the government and the excess profits that they make, they pay to the U.S. Treasury. It has been a Republican conservative part

part of the Wall Street agenda to return GSEs, Fannie and Freddie, out of conservatorship and return it to the private sector. Now I'm going to turn the reins over to you, Mark. You've done a lot of this work. Do you think that

it will be successful, returning it to the private sector. What challenges might they encounter? And why did it not work in Trump's first term? Let me first say that I would prefer that Fannie and Freddie were not a conservatorship. I think it would be better if they would

be able to come out of conservatorship and have an explicit guarantee so that homebuyers would enjoy even lower rates than they enjoy today. But I wouldn't release the GSEs from conservatorship unless it's going to land in a way where we're in a better place for taxpayers, for potential homeowners, homebuyers who need mortgages.

And that's a very difficult thing to do without an explicit guarantee. And the complicating factor there is very simple. To get an explicit guarantee from the federal government, you need legislation. You need Congress to pass a piece of legislation and for the president to sign that legislation. And that seems like a bridge too far. That's not going to happen. But

If you can't do that, that doesn't mean you have to go do something else that's going to make things worse. And all of the ideas for releasing the GOCs without that explicit guarantee land us in a worse place for taxpayers, for homebuyers, for the well-functioning of the housing and mortgage finance system. It's just a question of how much worse. And that depends on exactly what you mean by the release. You know, what does that look like? How is that going to be structured?

So my view is, first, do no harm. If you can't do that, just leave it alone. And again, conservatorship is not the place I'd like them to be, but I'll point out they've been there for 16 years. That's a full generation. And they're functioning just fine, thank you. They're doing what they need to do to get mortgages to American families, middle-income American families. And they've been quite successful.

Innovative and creative. In that 16 years, they invented the credit risk transfer market.

which means that they are offloading the risk they take, which means that they've effectively been privatized already. Private investors are taking the risk, the credit risk, not the GSEs. That was invented out of whole cloth a little over 10 years ago. They invented the single security, the securitization platform that make things more efficient. So they're operating very, very efficiently, effectively now.

in the 16 years. So I don't see any, you know, pressing reason why we have to do something unless we're going to do something to make it better. And all the proposals I've seen,

certainly that don't require legislation, the so-called administrative, which is what folks are talking about in the Trump administration, make things worse. We can debate how much worse, how much does it raise interest rates, how much does it curtail credit, how does it make the system less resilient, more vulnerable to business cycles, how it affects the ability to offload credit risk and make sure that that risk is privatized. All those things are affected by

by how exactly this is going to be done or how it's going to be structured, but all of them end up in a worse place than the existing status quo. So, you know, leave them where they are until we get a window, political window, to pass a piece of legislation to codify their current system, make it law, and get them the explicit guarantee that they need.

So the implicit guarantee is back when Fannie and Freddie were private entities, they had a special relationship with the U.S. government and they could secure financing at very low rates, a very low spread above Treasury rates because there was an understanding that people who bought the debt of the Fannie Mae and Freddie Mac

their debt was implicitly guaranteed that they would be paid back by the U.S. government if something ever were to go south, that the U.S. government were to bail them out. That is exactly what happened. I don't think anyone's ever lost a penny in terms of not being paid back, credit risk, of buying Fannie or Freddie debt. Of course, interest rate risk is a different story. But if it were to return to the private sector, you're saying that there has to be an explicit guarantee. There can't be an indirect

implicit guarantee? Why can't there be an implicit guarantee like there was before? Do you really want to go back to the future? I don't. Does that work out for anybody? You know, really? You want to go back to the way it worked, which failed miserably? I mean, yeah, there's been changes that make that less likely than it happens in the future. But really, why? You know, and if you go down that path, you're taking a chance with

the two largest financial institutions on the planet. And you're assuming that investors are going to treat them like they are treated in conservatorship. Really? These guys are in conservatorship. They're backstop. We know they're backstopped by the federal government. You send them out into the wild, release them.

with an implicit guarantee, investors are going to say, well, how does that line? That can't be as good as backstop I got now. The backstop I got now is the federal government. You're giving me something less than that. I don't know what it is exactly. Yeah, you can talk about PSPAs. You can talk about more capital. You can talk about this and that and everything else. But at the end of the day, come on, it's not the same backstop. It's just not. And depending on how much of a backstop you actually have with an implicit guarantee depends on exactly what you do or not do or how you do it and

It's very, you know, there's just no way to really know. And again, to what end exactly? Why are we doing this? Why? I mean, the system's working now. You're saying to me, I'm going to create a system that's going to work less well. And I, and I really don't know how well it's going to work. And I'm going to do that for what reason to, to what end? That's my point. To what end? Why would you do that? Do no harm.

But Mark, there are hedge fund managers who bought Fannie Mae stock at $1 and it's at $6 now. They only have a 500% profit. I mean, they need more money. Don't you agree? I'm not going to play into your sarcasm there, Jack. You said it, not me. I actually, being serious, I actually do happen to, I found your argument at the end of your piece convincing that the current system that we have now has actually worked really, really well.

that the private sector has been able to take the credit risk through credit risk transfer. Yeah, I'm happy. So you think it should either exit with an explicit guarantee or it shouldn't exit at all? I have no problem with people thinking about this carefully and going down all kinds of paths. We should do that.

I think it's great to have the discussion and debate. But at the end of the day, I don't think we should do anything unless it makes things better. For sure makes things better. This is really important. This is the big part of the global financial system. It's about getting people into homes with a 30-year fixed rate prepayable mortgage. As you pointed out, no one else on the planet has that. We only have that because of Fannie Mae and Freddie Mac and the government backstop.

So don't mess with that unless you have a really for sure good plan. And no one does. I mean, I looked at them all very carefully. The only better place to be is to release these guys out of conservatorship with an explicit guarantee from the federal government, from the federal government. Then I'm good. I think that's a better situation.

That satisfies you, Mark Zandi, in terms of financial stability and- Taxpayers, homeowners, financial stability, the mortgage finance system, everybody.

But political conservatives, people who care about fairness, they say you can't privatize the profits and socialize the losses again. We've privatized them. That's just a bogus argument. They've been privatized. These guys, they take, they insure the credit risk, they turn around and they offload the credit risk to reinsurers and to the capital markets, which means

asset managers, sovereign wealth funds, insurance companies, pension funds, hedge funds. It has been privatized. These guys are nothing but intermediaries for interest rate risk and credit risk at this point in time. So they got mission accomplished. But there are profits from intermediation and those profits from intermediation are currently paid to the U.S. Treasury and not paid to people who own FNMA, right? It's the taxpayer owns Fannie Mae and Freddie Mac. They own it.

The taxpayers should reap the benefit of the profits that are being generated by these companies. So tell us about these ratings. So, you know, Moody's Ratings has a triple A rating when assuming the government backstop. You write how prior to withdrawing it a decade ago, Moody's Ratings effectively gave Fannie Mae and Freddie Mac a rating well below investment grade. So you think these things cannot function as investment grade ratings and therefore be bought by investors.

an ETF or a mutual fund? That was back in the day. That was in 2014. And they're in much better shape than they were back then. They've been restructured. So hard to know how the rating agencies would respond and what the standalone rating would be. But my sense is it would be on par with like a JPMorgan Chase, systemically important financial institution. You could argue there's different countervailing kind of

forces here when you compare the credit quality of a Fannie Mae versus a J.P. Morgan. On the one side, you have J.P. Morgan has a diversified asset base. The Fannie Mae and Freddie Mac are monolines. The funding sources that J.P. Morgan has are more varied than Fannie Mae and Freddie Mac. So that'd be another reason why you think

JP Morgan might be a higher credit, better credit quality, better credit. But there's other forces on the other side. We're talking about plain vanilla mortgages, highly capitalized intermediaries of risk. They're not taking actual risk on the balance sheet. So I could see lots of different arguments on either side of it. But that's the kind of thing that I would think ultimately. But

You know, I'm speculating here. I'm not in the rating agency and I don't have any inside information. It's just, you know, but they will play a role here in determining how this, if there is a release or an attempt to release, how things play out. So you said Fannie Mae and Freddie, they sell a lot of the credit risk.

of mortgages. The same report I quoted earlier from the Federal Reserve about how credit card delinquencies are the highest they've been since 2011. Mortgage delinquencies are incredibly low. Incredibly. Very, very low. Can you just talk about, well, number one, how that indicates to the economy as well as...

that impacts Fannie Freddie, as well as I know you're on the board of MGIC, which is a mortgage insurance company. Yeah, credit quality is fantastic, right? And that goes to 4% unemployment rate. People are working. Wage growth is strong, higher than the rate of inflation. And house price growth has been very strong for lots of different reasons. So people have been able to build up a lot of equity in their home. So even if a person loses their job, which is pretty rare, layoffs are very low,

and they can't make their mortgage payment, they still have a lot of equity in the house and they're not going to default on the mortgage because of that equity. So it's a very good time in the mortgage market. And of course, the other point is important. Many homeowners refinance when rates were low. This goes back to the 30-year fixed rate before payable mortgage. They locked in incredibly low interest rates. So their mortgage payments are very low. But really the only

growing problem for people is cost of homeowners insurance and property taxes, mostly homeowners insurance in places that are being affected by climate. Florida, California now,

Texas, that's the real issue. But in terms of the actual mortgage payment, it's very low and obviously it's locked in and that makes the risk here very, very modest. And even new originations, the debt to income ratios are high because house prices are high and affordability is low. So people need to take on more debt relative to their income. But if you look at other risk measures like people's credit scores or their

loan to value ratios, it all looks pretty good. So credit is really, really, really good.

You write how if the GSEs were to be reprivatized, that it would be the largest IPO in history. Tell us what that would look like, as well as do you think that would the U.S. taxpayer have a mark-to-market gain by selling it back, even though it no longer owns Fannie and Freddie, so it has that loss, but it's kind of on paper, but would that

make the debt, would that knock the debt down by a few hundred billion if it were to do an IPO? Yeah, it's just going to be a big IPO, which complicates things, right? I mean, you've got two large institutions and it'd probably be the largest IPOs, which just makes it even more difficult to release them in a graceful way.

And I'm not sure how you could do that until investors had a real clear sense of what the business model is and what's working and what the footprint is. And that could take years. I don't think a long time before you get to a place where investors feel comfortable enough to plunk down the kind of cash that would be needed to IP them. Just just another whole set of complications around the idea of releasing them from from the current conservatorship. So I think that that would be that would be very difficult.

And so you don't think releasing it without an explicit guarantee is a good idea, but let's say that it were released. It did IPO without an explicit guarantee. You said earlier the consequences would just be higher mortgage rates, higher MBS spreads over treasuries, I guess. What else? And how bad do you think it would be? Higher rates, fewer people would qualify because who they could lend to would be more narrow. Their footprint would be smaller.

They'd be more vulnerable in more stressed economic environments. Their cost of capital would rise. It'd be more difficult to transfer risk. So they can't play the same kind of counter-cyclical role that they play now.

I mean, think about what Fannie Mae and Freddie Mac did during the pandemic. They stepped up and provided mortgage forbearance and stopped foreclosures. And it happened very quickly only because they were part of the government under conservatorship. If they were private institutions, that may never have happened. And if it did, it would take a long time for that to happen.

So, yeah, there's all kinds of implications for if you release them. And I'm right. And investors look at them differently because they have the implicit guarantee. They don't have the guarantee that's obvious that they have in conservators. You mentioned one thing I forgot to answer was around the IPO pricing. Can taxpayers make money? The answer is no, because, you know, what they'll do is they'll sell.

the institutions make money there, but in terms of what it means for the budget, you have to net out the present value of the stream of future projected earnings. And if the IPO is fair value, if it's market value, which has got to be roughly equal to the PV of future earnings, the net of all that's going to be zero. It's going to be a wash. So you can't count on selling these guys to make any cash to

you know, pay for tax cuts or whatever you want to spend the money on. You can't deficit reduction or whatever it is. You're not going to make from a, from a scoring perspective, you know, budget scoring perspective, you're not going to be able to make any money.

from the long CBO report that not a lot of people will read, sure. But there's nothing preventing President Trump from tweeting, we just made $300 billion for the taxpayers, right? Yeah, but you're giving up $300 billion in the future because you just got rid of the asset. So, Mark, earlier I referenced that the Federal Reserve can't buy assets that aren't government guaranteed. This is a matter of law. It's a reasonable legal question.

But one of the questions is, can they buy the MBS and debt of Fannie Mae and Freddie Mac in a release period?

if it's an implicit guarantee. And they're not government agencies. So it's an open question. If they can't, that's obviously a real problem, right? Because one of the things that investors look at when they invest in Fannie Mae, MBS, Freddie Mac MBS, mortgage securities, is that they're effectively, they get another backstop from the Fed who can come in and buy their securities in really stressed environments and help support the mortgage securities.

But the question is, can they? And I think that's a legal question. It really does depend on the release, the nature of the release. I guess the Fannie Mae going into conservatorship was before the Fed did quantitative easing and started buying in 2008. Yeah. Yeah. And it really goes to the nature of are these considered government agencies in the release that we're talking about in the future?

In the interest, I don't know. It depends on what the release looks like. Very interesting. Well, Mark, thanks so much for coming on Monetary Matters. You have any closing thoughts to share with the audience? Thanks. That was pretty wide ranging. It was a good economic stress test for me. So thank you. Cover a lot of ground. I really appreciate the opportunity and thank you for that.

Thank you. People can find you on Twitter at Mark Zandi. You've got a podcast, Moody's Talks, called Inside Economics. Yeah, just quickly tell people about where people can find you at Moody's Analytics, as well as the work that Moody's Analytics does and how that differs from the ratings work that people may be slightly more familiar with.

Yeah. I don't think we have to go into any detail, but you can find me on X at Mark Zandi or Blue Sky at Mark Zandi or the Inside Economics podcast. Very proud of that. Been doing that weekly for the past four years. I think if folks like this podcast, because we were pretty nerdy, we got down into the weeds. You'll like Inside Economics. There we go. Thanks again, Mark. Thanks everyone for watching. Thank you. Just close this door.