Economy With solid progress on inflation, the Fed began an easing cycle in 2024. However, January will usher in a new administration and policies contemplated under Trump 2.0 may not be bondholder friendly. While the market has mostly shrugged off concerns to date, President-elect Trump's policies may lead to greater deficit spending and increased borrowing. This could lead the Fed to slow the pace of rate cuts if inflation proves to be sticky.

Policy On the regulatory front, we expect that the Trump administration will be more open to approve mergers and acquisition activity. High yield issuers are often the target of M&A, and strategic purchases of high yield companies by investment grade buyers may lead to price appreciation. Additionally, if animal spirits run rampant, we could see the return of leveraged buyout activity to the high yield market. While the new issue market in US high yield bonds has been dominated by refinancings the last several years, a rise in M&A activity, LBOs, or loan-to-bond transactions, should lead to more net new issue volume in 2025. Prudent credit underwriting will be important to prevent higher default activity in coming years. For 2025, we continue to expect a lower than average high-yield default activity given the low percentage of distressed securities which is currently around 2.5% of the market.

Valuations We believe the high yield market is currently "priced for perfection" making security selection paramount. Spreads in the high yield market are approaching levels not seen since before the GFC. The spread to Treasuries (as measured by the Credit Suisse High Yield II benchmark) was 301 basis points at November month-end versus a long-term median of 489 basis points. Spreads have only been tighter in 1% of history! Spreads are also highly compressed, with the dispersion between the 75th and 25th percentiles of OAS at 25-year tights. While spreads may remain at these current tight valuations for long periods, investors need to be aware of downside risk potential. Any change in economic outlook, geopolitical risks, or earnings that changes the market's appetite for risk assets may cause spreads to widen.