When it comes to predicting where the economy is headed, no one has a crystal ball, but Mark Zandi may be the next best thing. Chief economist of Moody’s Analytics, Zandi frequently testifies before Congress, serves as an advisor to policymakers, and is a regular guest on CNBC and other national media outlets. He co-hosts the Inside Economics podcast and is a noted author, with The New York Times calling his book on the subprime mortgage implosion the “clearest guide” to the 2008 financial crisis.
On October 2, Zandi headed uptown for a fireside chat with Harry Mamaysky, professor of professional practice and director of Columbia Business School’s Program for Financial Studies (PFS). In addition to supporting the School’s research in financial economics and quantitative finance, PFS administers the highly selective Master of Science in Financial Economics — a rigorous program that draws on both PhD and MBA courses to provide a quantitative, industry-oriented finance education.
In the course of their wide-ranging discussion, Mamaysky asked Zandi about his outlook on inflation, interest rates, and the economy, as well as the advice he’d give MBA students starting out in their finance careers.
Here are five takeaways from the evening.
1. Higher 10-year yields shouldn’t be surprising.
Inflation is easing, which usually correlates with falling interest rates. Yet, as Mamaysky noted, the 10-year Treasury yield in early October was closing in on 5 percent, its highest level in 16 years. Zandi examined the apparent contradiction by dissecting three distinct factors in the recent 150-basis-point (bp) spike:
- First, Zandi noted that inflation expectations — what bond investors believe inflation will be in the future – remain unchanged, so they have not contributed to the higher rates. This is encouraging, because if higher inflation expectations were behind the run-up in rates, the Fed would be under pressure to increase short-term rates even more.
- Second, Zandi pointed to higher expected real short-term interest rates. Bond investors were slow to believe that the Fed would follow through on its “higher for longer” policy (that it may not raise rates again but won’t be lowering them any time soon). They’ve recently indicated that they’ve bought into the policy but not before bidding up long-term rates. This has contributed approximately 50 bps to the 150-bps increase in 10-year Treasury yields.
- Third, Zandi attributed the final 100 bps to an increase in the term premium — the extra yield investors require for the risk inherent in longer term debt instruments. Adding to the risk is the US government’s large budget deficits, the nation’s increasing debt load, and the dysfunction in Washington, DC, which calls into question the ability of lawmakers to address our fiscal problems.
2. Expect to see the US economy slow.
The economy enjoyed a strong third quarter, expanding by nearly 5 percent. But Zandi identified a number of headwinds that should combine to cool things off: the effects of the Fed’s rate hikes; the end of the student loan moratorium; another potential government shutdown; and the United Auto Workers' strike. Together, these factors should result in fourth-quarter growth that is close to only 1 percent.
Zandi added that long-term rates should ultimately fall in line. “In my view, the 10-year yield should be somewhere just above 4 percent. That's equal to the nominal potential growth rate of the economy in the long run,” he said. “Clearly, there are periods of deviation, but in the long run, the potential growth is the return we should be getting. That’s the anchor.”
3. Don’t assume banking’s problems are over.
Since the regional bank crisis in March, the sector has been relatively quiet. But Zandi warned that all is not well. “The financial system blew a gasket back in March,” he said. “And the Federal Reserve and other regulators put the gasket back on and taped it up with the Bank Term Funding Program, guaranteeing all depositors above the deposit insurance limit and doing everything they needed to do to keep the system working. But that doesn't mean the system is in a good place.”
Credit quality has been artificially supported by federal COVID-related guarantees, he said, but as that support fades, credit quality is weakening and defaults should start pushing higher.
Both the regulatory environment and underwriting standards have tightened, leading to fewer loans. And banks are dealing with an inverted yield curve, having to pay out more in deposit interest while receiving low interest on existing long-term loans.
4. Despite US debt, Moody’s remains optimistic about the US economy.
Mamaysky observed that Moody’s has maintained its top AAA rating on US debt, making it the only one of the three major rating agencies to not downgrade. Zandi acknowledged some troubling economic facts — in particular, the country’s debt-to-GDP ratio, which is currently 100 percent. Assuming general fiscal policy remains the same and historically normal economic conditions prevail, that ratio is forecast to rise to 115 percent in 15 years and 180 percent in 30 years — an unsustainable trajectory.
Still, Zandi said he believes in the United States, paraphrasing the humorous words of Winston Churchill: “You can always count on Americans to do the right thing — after they’ve tried everything else.” Zandi compared today’s situation to that of the 1990s, when the interest payments on US debt alone equaled 5 percent of GDP and almost exceeded defense spending. The situation was dire enough that politicians could “connect the dots'' and see that they’d be voted out of office if they didn’t resolve the problem. Today, the interest payments are less than 3.5 percent of GDP, and despite recurring debt limit showdowns, Zandi said he remains optimistic that the United States will ultimately choose the right fiscal course.
5. Even in rough financial markets, backstabbing isn’t the answer.
At the end of an evening spent unpacking current economic challenges, Mamaysky asked what advice Zandi could offer MBA students entering the field of finance. While acknowledging the vital role of a solid education and business savvy, Zandi made the case for kindness as the often overlooked path for success in what’s often perceived as a cutthroat industry in a cutthroat city.
“I know a fair number of CEOs, and the one common denominator is they're not what you see on [the television show] Succession,” he said. “They are genuinely nice people. You don't become a leader of a large multinational organization unless people earnestly like you and trust you. And you can't do that unless you're nice.”
Editor’s note: Some quotes from the original CBS event were edited for clarity.