Systematic Insights: Is this high yield’s Goldilocks zone? | Insight Investment

We recently explored how US high yield might perform over 12 months though different economic scenarios, from growth (likely the most beneficial) to stagflation (likely the most challenging).

The current consensus, based on the latest median estimates of FOMC members and economists, appears to be for a slowdown in economic activity, but not a contraction. These estimates are largely in line with Insight’s own current in-house forecast (Figure 1).  

Figure 1: The consensus appears to be for GDP growth to slow but not contract¹

Slowing activity appears evident in the labor market, which appears to have entered a “low hiring, low firing” regime. Payroll growth is not only slowing, but also increasingly limited to certain market segments (Figure 2).

Figure 2: The labor market appears to be in a “low hiring, low firing” phase²

Our base case is that the labor market will not tip into a contraction. To the extent that becomes a real threat, we would expect the Fed to ease policy with an aim to protect the market from tipping into a vicious cycle of job losses. In this scenario we would expect the central bank to “look through” tariff inflation risks.

Could an economic slowdown suit high yield?

On average, when US GDP has fallen from above 2% to a range of 0% to 2% (mirroring the current forecasts), US high yield has tended to outperform US Treasuries, US investment grade and the S&P 500 (Figure 3).

In our view this reflects the fact that slowing but positive GDP growth implies that, on average, corporate profits will be harder to grow, but existing debt will be no harder to service.

Figure 3: US high yield has historically performed well through a slowing GDP growth environment³

In a world in which we expect defaults will remain contained, we believe the current environment could be a compelling backdrop for high yield investing.