Chip Somodevilla

The Federal Reserve voted unanimously on September 16 US time to raise interest rates by 0.25 percentage point, lifting the federal funds target range to 3.75% to 4%. It was the first rate increase since July 2023. Mark Zandi, chief economist at Moody’s Analytics, had already issued repeated warnings and said on Monday that the economic damage caused by high rates was beginning to emerge.

In a post on X on September 13, Zandi said the likelihood that the Fed had made a “serious policy mistake” was “uncomfortably high and rising”. His reasoning at the time was that US economic growth was close to its potential rate of about 2%, while unemployment was just above 4%. Although inflation was above 3%, it was mainly being driven by supply shocks such as energy prices and tariffs, which higher interest rates could not resolve.

Speaking to Yahoo Finance on Monday, Zandi said: “I think the economy is going to start to weaken because of the rate hikes.” He noted that, in addition to the rise in the policy rate, long-term yields that influence borrowing costs had also climbed. The 10-year US Treasury yield rose to 5.22% on Monday after reaching its highest level since 2007 the previous week, while the 30-year fixed mortgage rate rose to 7.5%, its highest level since spring 2024.

The key issue is how long it lasts. Zandi said that if high rates persisted for only a few months, the conflict in Iran ended, oil prices fell and markets no longer expected further rate increases, high rates “would hurt the economy, but not cripple it”. “But if it goes on longer, into next year, I think the economy is really going to struggle.” Markets currently expect another three to four rate hikes over the coming year, including one more this year.

Zandi warned that if those expectations materialised, a wave of corporate bankruptcies could follow. He said many heavily indebted companies had managed to hold on so far because private equity owners had extended the maturity of their debt to reduce repayment amounts. He added that a longer period of high rates would increase the burden on households with credit card debt and home equity lines of credit, or HELOCs.

Technology giants investing in AI could be the only exception. Zandi said: “AI has a momentum of its own, and the market has very high expectations for future profits. As long as that continues, hyperscale data-centre operators can afford these rates, and even higher rates, without it doing too much damage.”

As for the stock market, he did not believe rate rises alone would cause US shares to plunge. “Higher interest rates are an erosion of valuations, not a cliff event.” He likened it to “corrosion on a marble floor” that would take a long time, but said the market could turn if the floor was weakened — for example, if Nvidia’s earnings fell short of expectations.

There are differing views on why long-term yields have risen so sharply. Federal Reserve officials led by Kevin Warsh see the move as a sign of a strong economy, while Zandi believes geopolitical tensions and market uncertainty are the main causes. He also said the Fed chairman’s decision to stop providing forward guidance had prompted investors to demand additional compensation, which he estimated had added a premium of several basis points to long-term yields.

Zandi also expressed concern about a US debt-ceiling standoff next autumn. If divided government emerged after the November midterm elections — with Democrats taking control of either one or both chambers of Congress — a legislative deadlock could roil the bond market.