Tariffs Could Blow Up the Bond Market | Mark Zandi on the Biggest Risk to the Economy

Episode Summary

Executive Summary: Mark Zandi argues the U.S. economy has achieved a soft landing, with strong growth, low unemployment, and inflation near target, but warns policy uncertainty—especially tariffs, immigration crackdowns, tax cuts, debt, and deficits—could push bond yields higher, pressure asset prices, and raise recession risk. He also says broad tariffs are economically harmful, while Fannie/Freddie should remain in conservatorship unless released with an explicit federal guarantee.

Main Topics: U.S. economy and soft landing (Priority: 5/5): Zandi says growth, jobs, inflation, and asset prices show an exceptionally strong economy and credits the Fed with delivering a soft landing, while acknowledging it could still be derailed. Bond market, inflation expectations, and rate risk (Priority: 5/5): He frames the bond market as the key macro risk, arguing higher yields are being driven mainly by inflation/deficit fears rather than stronger growth, which threatens valuations and consumption. Tariffs, trade policy, and inflation (Priority: 5/5): Zandi strongly opposes broad-based tariffs, calling them a negative supply shock that raises prices, slows growth, and provokes retaliation, especially from China and other trading partners. Immigration, deportations, and labor supply (Priority: 4/5): He argues immigration has eased labor shortages and supported growth, while large-scale deportations would tighten labor markets, increase wages and prices, and worsen housing and food inflation. Federal Reserve policy and inflation path (Priority: 4/5): Zandi says the Fed is pausing because policy uncertainty, sticky inflation, and potentially a higher neutral rate make further cuts difficult until fiscal and trade policy become clearer. U.S. debt, deficits, and default anxiety (Priority: 4/5): He warns rising debt, interest expense, and political dysfunction are pushing up CDS spreads and could eventually force investors to demand higher risk premia on Treasuries. Fannie Mae/Freddie Mac conservatorship and housing finance (Priority: 4/5): Zandi says the GSEs should not be released unless there is explicit federal backing; otherwise mortgage costs, credit availability, and financial stability would worsen.

Key Arguments: The economy is performing exceptionally well: GDP growth, job creation, unemployment, inflation, and asset prices all point to a successful soft landing. The biggest macro threat is policy-driven inflation—tariffs, tighter immigration, deficit-financed tax cuts, and Fed interference—not weak growth. Higher long-term rates matter because they can compress valuations, reduce wealth, and undermine consumer spending concentrated among higher-income households. Broad-based tariffs are a bad idea because they act like a tax on consumers, raise inflation, slow growth, and trigger retaliation and supply-chain disruption. If tariffs are large enough and persistent, they could push the 10-year Treasury yield high enough to cause recession; Zandi’s model suggests around 7% for multiple quarters under inflationary conditions. The strong dollar is partly benign because the U.S. economy is stronger than peers, but it is also worrisome when driven by tariff expectations and trade-war risk. Large deportations would reduce labor supply in construction and agriculture, worsening housing and grocery inflation. The Fed’s pause is rational because it cannot calibrate policy until it knows the scale of tariffs, immigration restrictions, and fiscal changes. Debt and interest expense are becoming more troubling; rising deficits and political brinkmanship around the debt ceiling could further lift borrowing costs. Fannie Mae and Freddie Mac already function effectively under conservatorship with credit-risk transfer, so release without explicit guarantee would likely make the housing finance system worse.

Data Points: U.S. GDP growth (Q4 2024 est.): around 3% - Zandi’s estimate for fourth-quarter GDP growth and roughly the year’s growth rate Monthly job growth: around 150K - He says this pace is enough to keep unemployment low Unemployment rate: about 4% - Described as low across demographics Core inflation: 2.7%–2.8% - Zandi says core inflation is just below 3% and still above target Fed inflation target: 2% - Referenced as the goal inflation is approaching but not yet at 10-year Treasury yield: about 4.6%–4.7% - Current level discussed as potentially manageable but still risky if it rises further Potential recession threshold (model): around 7% for multiple quarters - Zandi’s model says this could produce two consecutive quarters of negative GDP growth Long-term yield baseline range: 4.25%–4.5% - His most likely expectation for where yields may settle Recession probability: 25% over the next year - Zandi’s estimate of elevated recession risk Typical unconditional recession probability: about 15% - Used as a historical baseline for comparison Top third of households' spending share: 55% - Zandi says upper-income households account for most consumer spending Bottom third of households' spending share: 15% - Used to show low-income debt stress has limited macro impact Credit card APR: 23.5%–24% - He cites current average rates as very burdensome for low-income borrowers Credit card delinquency peak: just about 4% - Peak last summer, higher than pre-pandemic but below crisis levels U.S. debt-to-GDP: 100% of GDP - Used to illustrate rising sovereign leverage Federal interest expense: over $1 trillion in 2025 - Projected to exceed defense spending Mortgage market delinquency: incredibly low - Attributing this to low unemployment, strong equity, and fixed-rate loans Immigrant share of construction trades: almost 30% - He says deportations would hit housing supply and rents Share of immigrant construction workers who are undocumented/unauthorized: about half - At significant risk under large-scale deportations Typical annual deportations: 250,000–350,000 - Zandi says that level would probably be manageable Potential large-scale deportations discussed: 500,000–800,000 - He says this could materially tighten labor markets and raise inflation China-related tariff figure from first term: $300 billion in imports - He notes Trump’s earlier tariffs were relatively modest versus total U.S. imports Total U.S. annual imports: about $3.5 trillion - Used to frame first-term tariffs as limited in scope

Pivotal Quotes: "It’s strong. I mean, I’d say exceptionally strong." — Mark Zandi: Describing the current U.S. economy and arguing the soft landing has been achieved "Tariffs are a bad idea. Broad-based tariffs are a really bad idea." — Mark Zandi: Summarizing his view that tariffs raise inflation and slow growth "We’re going to pay more in interest expense as a nation than on our own defense in 2025." — Mark Zandi: Explaining why federal debt and interest costs are a growing macro risk

Implications: Listeners should expect continued strength unless policy shocks hit growth or inflation. The main watch items are tariffs, bond yields, and immigration policy, which could raise prices, weaken markets, and strain housing and labor supply.