Moody's Zandi warns that higher interest rates are already damaging the economy

Moody’s chief economist Mark Zandi warned before this month’s Fed meeting that a rate hike would be a “serious Fed policy mistake.” Now, with rates higher and more increases expected, he says the economic damage is already happening.

“I think the economy is going to start to sag as a result of the rate increases,” Zandi said in an interview with Yahoo Finance on Monday.

Not only is the Fed’s benchmark policy rate higher, he noted, but long-term bond yields, which affect borrowing rates, are also up. The 10-year Treasury yield (^TNX) climbed to 5.22% on Monday after hitting a 20-year high last week, while 30-year fixed-rate mortgages hit 7.5%, the highest since spring 2024.

The key is how long rates remain high. Zandi noted that if higher rates persist for only a few months, the conflict in Iran ends, oil prices come down, and the further rate increases anticipated by markets do not materialize, then higher rates will hurt but not hobble the economy.

“But if it goes on for much longer than that and into next year, I think the economy will really start to struggle,” he said.

Markets are pricing in three to four additional rate hikes over the next year, including one more hike in 2026. The central bank raised rates by a quarter percentage point to a range of 3.75% to 4% on Sept. 16, the first rate hike in more than three years.

Read more: How the Fed rate decision affects your bank accounts, loans, credit cards, and investments

Zandi warned that if market expectations manifest, a wave of corporate bankruptcies could follow. He noted many heavily indebted companies have survived solely because private equity owners extended debt maturities to keep payments low.

Zandi also said higher rates for longer will put increasing pressure on households with credit card debt and home equity lines of credit, who will pay more.

Technology giants investing heavily in artificial intelligence may be the sole exception. Because tech juggernauts are taking on debt to build data centers and the underlying AI infrastructure, their high margins will allow them to absorb higher borrowing costs.

“AI is running on its own dynamic, and expectations for future profits are quite high,” Zandi said. “So as long as that continues, then hyperscalers will be able to pay this interest rate plus a lot more, and it won’t do a lot of damage.”

What’s behind the jump in yields? Disagreement.

A fundamental disagreement remains over what is driving long-term yields higher. While Warsh and other Fed officials view rising yields as a sign of robust economic growth, Zandi points to geopolitical friction and market uncertainty.

He also thinks a couple of basis points of premium have been built into long-term government bond yields because the Fed chair no longer offers forward guidance, and investors need compensation for not knowing what exactly the Fed will do.

Looking ahead, Zandi is increasingly concerned about a looming debt-limit battle next fall. If the midterm elections result in divided government — with Democrats taking one or both houses of Congress — Zandi worries that could create a logjam that hurts the bond market.

Despite the upside risks to bond yields, Zandi does not believe higher rates alone will cause a sudden collapse in the booming stock market.

“The run-up in rates is a corrosive on valuations. It’s not a cliff event,” he said. “It’s a corrosive on marble floor for AI, so it’s going to take a lot. But at some point, if you undermine the floor … like Nvidia falls short of earnings expectations, then that could cause the market to turn.”

Jennifer Schonberger is a veteran financial journalist covering markets, the economy, and investing. At Yahoo Finance, she covers the Federal Reserve, Congress, the White House, the Treasury, the SEC, the economy, cryptocurrencies, and the intersection of Washington policy with finance. Follow her on X @Jenniferisms and on Instagram.

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