'Something could break': The Fed risks recession, bank failures if it doesn't cut rates soon, economist Mark Zandi says

• The Fed risks "breaking" something in the economy if it delays rate cuts, according to Moody's Mark Zandi.
• Higher interest rates raise the odds of recession or bank failures, the economist warned.
• "If I were king for the day, I would really be cutting rates at this point," Zandi told Yahoo Finance.

The Federal Reserve would be better off cutting interest rates as soon as possible, as there are parts of the economy at risk of "breaking" if rates don't come down, according to Mark Zandi, the chief economist of Moody's Analytics.

Speaking to Yahoo Finance on Thursday, Zandi warned of the consequences that could arise if the Fed doesn't cut interest rates over the next few months. Keeping rates at their current level raises the risk of recession, and could expose other cracks in the financial system, Zandi warned.

"Those rates are corrosive on the economy. They wear the economy down, and at some point, something could break. The risk that they're taking here is that they undermine the economy and recession occurs," the top economist said. "If I were king for the day, I would really be cutting rates at this point, because I do think the economy could use that relief."

The strength of the economy suggests that the US isn't close to hitting a recession, Zandi noted, but higher interest rates have already started to take their toll on the economy. Elevated borrowing costs have led to sluggish loan growth and are "eroding" credit conditions, he noted, which could stress banks' balance sheets.  

Zandi pointed to regional banking failures last year, with the initial collapse of Silicon Valley Bank sparking a brief banking crisis that led two other lenders to fail.

"That's the kind of thing I'm worried about in the context of persistently high interest rates," he said.

Other market commentators have warned of more banking turmoil as borrowing costs stay elevated. Billionaire investor Barry Sternlicht predicted the US could face weekly banking failures, in part due to the impact of high interest rates on commercial property loans. 

But central bankers look poised to keep interest rates higher for longer, as the Fed is looking for more evidence that inflation is on track to fall back to its 2% target. Prices have grown hotter than expected for the last three months, with inflation clocking in at 3.5% in March.

The Fed will likely wait another two or three months before moving to ease monetary policy, Zandi predicted, as central bankers are waiting on cooler inflation data.

Markets are eyeing April inflation numbers to roll out next week, but hopes for aggressive rate cuts this year have been dashed. Investors are pricing in just one or two cuts by the end of 2024, according to the CME FedWatch tool, down from six predicted at the start of the year.