Andy D’Souza: Welcome back to The Investment Conversation. I'm Andy D'Souza, partner and chief marketing officer here at Lord Abbett. As part of our 2025 Midyear Investment Outlook, we're going to talk with our investment leaders about key themes for the markets in the second half of the year across equities, municipal bonds, taxable fixed income, and private credit.

Today I'm going to speak with our co-heads of taxable fixed income, Steve Rocco, hey, Steve.

Steve Rocco: Hey, Andy. Good afternoon.

Andy D’Souza: Good afternoon. And Rob Lee. Rob.

Rob Lee: Hey, it's great to be here.

D’Souza: All right. Great to have you guys. So, let's continue our conversation from earlier this year. Back in January we spoke about the markets. One of the issues that came up at the time that you both brought up was the idea of tariffs. Little did we know what was going to happen on April 2 in many ways, and it came to be a surprise and a shock to the markets, to say the least or to be the understatement of the year maybe. We've had a wild ride in the markets since then. As the dust begins to settle, we think, at this point, would you mind walking us through some of the broader economic and market backdrop today? Maybe I'll start with you, Rob.

Lee: Sure. So, I'd say we entered this year, 2025, with fundamentals (broadly speaking, economic fundamentals), pretty strong. So that meant healthy company finances. Think good revenue, think pretty high margins, think earnings growth very positive.

Same thing on the consumer side, generally speaking, healthy consumer balance sheets. Consumer spending in the second half of last year was strong. A lot of wealth creation over the past few years with markets rising and home prices rising.

So fundamentally, it looked pretty good, and the markets and investors were positive on the Trump administration being business-friendly and supportive of the economy in general. That certainly includes a Republican Congress, both chambers of Congress, a unified government.

So, all very positive. You're right when the tariff news hit, in particular April 2, the so-called Liberation Day, that was a negative surprise and shock. And I'll put a little bit more detail around that. I'll use rough numbers. If the effective tariff rate for the United States was pretty low at 2.5%, if the Liberation Day announcements (along with some of the other tariffs that went into place even before April 2), went into place fully and completely forever you would go from an effective tariff rate in the U.S. of 2.5% to something like 20% to 25%.

So, a different order of magnitude--10 times. And what people pointed to was roughly 90 years ago, massive tariffs, talk about the Smoot-Hawley Act, and basically putting a lot of sand in the gears of international trade. So, when you go from 2.5% to, call it, 22.5% tariff rate in particular certain countries (China, most specifically), very high tariff rates would have impacts across the entire U.S. economy.

And therefore, you had a lot of negative risk asset price action in the markets, stocks, high yield [bonds], pretty much anything with risk. The perception of recession risk and recession probability shot up a lot. And that's kind of what happened in early April.

The last thing I'd add here, and we can talk more about it, is since then, over the past four or five weeks, there's been some dialing back. There's been some climbing down. There's been some negotiation, most recently with China, which is a very big trading partner for the U.S.

And I think markets, rightfully so, see that it isn't the worst-case scenario, there is a so-called “Trump put,” and cooler heads are prevailing and thus recession probabilities have gone back down a fair amount, and we've retraced in spread product and risk asset prices some or all of the way, depending on the market. So bad news and then a fair amount of good news and climbing down and stepping back.

D’Souza: Anything to add, Steve?

Rocco: Sure. So, I'd say a couple things. I think you have to look at Trump policy in three parts. So, I think you have to look at the tariff piece. It's funny, because when we talked in January, we talked about this idea that presidents usually do what they say they're going to do, people do what they say they're going to do.

And he clearly likes tariffs. And there was obviously some element of that at play here. I think also then you think about the next piece, which would be taxes and deregulation. So, I think it's kind of a three-part agenda. I think this first part, I can't say we're through it yet, but I think we're getting closer.

I think, as Rob said, the administration kind of showed their hand, whether it was the bond market, the stock market, that kind of trigger, it really doesn't matter all that much. I think if you talk about the level of tariffs, Rob pointed out 2.5% before Trump up to potentially 20-25%, which you at kind of Great Depression levels.

Clearly a negative. I think where it lands, I think we will have tariffs, and it probably will stick at that 10%, partly as a pay-for for the second piece, which is taxes and which we can get to. And then if it's anything higher than 10% it'll be the sectoral, and that would be things like on aluminum and steel or potentially autos that may or may not stick. So, where it shakes out, I think the market is kind of somewhere around 13%. And I think what we should keep in mind too is growth has been slowing, with or without tariffs.

We haven't felt the impact of tariffs yet. And so, growth has slowed in Q1, and I think tariffs are a tax, right? So, I think that is a negative impulse, not as large as obviously the market was expecting a month ago, but clearly some negative impulse.

So, growth in the U.S. has slowed and may continue to slow. Actually, one of the things that has been interesting in this period is the sentiment and the “soft” data [consumer and business sentiment surveys] has been very weak. Think of survey data, consumer sentiment. But the hard data's [actual measures of prices, output, etc.] actually been okay, but the hard data you would expect if you have some level of tariff, that would weaken a little bit.

So, thinking about the go-forward in the U.S., you may be in a slower growth environment moving forward. Also, I'd say non-U.S. is interesting as well. I think Europe, a lot different than the U.S. here at this moment in time, where obviously there will be potentially some tariff impact, given the markets that they serve.

But there you have a central bank that has been cutting [rates] and also what this has unleashed (and I think we talked about this too in January), was massive fiscal stimulus, which is almost unheard of in Europe. And you have the Germans now stimulating.

So, I think the growth trajectory in non-U.S. markets, even at factoring in the impact of tariff is somewhat positive. China clearly would be impacted more, at the lower levels obviously less, there's some element there of stimulation potentially to the offset.

And I think China was prepared for tariffs in some way. Still a negative headwind but the non-U.S. growth impulse is interesting. I think that's what you've seen--one of the stories this year so far has been a divergence in U.S. versus non-U.S. performance.

Some of that is U.S. markets [are] so levered to technology and AI, some of that in the beginning of the year was maybe some worry about in January, [the launch of AI platform] DeepSeek and [the possibility of lower] spending in AI, I think that's corrected itself here recently. I think there's been more bullishness around AI and seeing the U.S. market come back a little bit.

But the dispersion, say, between the German stock market and U.S. stock market is over 20%. And it seems true in many emerging markets, so you've seen that. And it's been a long time, actually, since you've seen that. So, I think that's another kind of interesting piece this year as well.

D’Souza: And some of these divergences and some of the volatility we see in the industry (you both mentioned), in the first half at least, although maybe quieting down now, maybe. You've been running money for decades at this point. Could you put this in context and historical perspective? How volatile has this first half been, in your minds? And maybe we'll start with you, Rob, and then back to you, Steve. I'd love to hear from both of you on this.

Lee: Yeah. Perspective is important here. So, April I'll point to as the peak volatility month so far this year. When you put it in the perspective of March of 2020 when COVID hit, if you put it in the global financial crisis back in 2008, I don't think it rises to that level.

Don't get me wrong, equity vol [volatility], for example, spiked up high. All the policy uncertainty indices spiked up very high. But the reaction in most markets was, I'd say, very noticeable, painful for a short period of time, but I don't think it rose to the level of the worst crisis we've seen in the last 20 or 30 years.

D’Souza: Steve, you agree--

Rocco: Yeah, I absolutely agree with that. And remember also too all the promise coming in, right, all the bullishness coming into the first months of the Trump administration. Some of that had to be unwound obviously. So that played into it.

It felt worse than it was from the high in February. But markets correct, you know, and we always joke like, "People say, 'I'm waiting for a 10% correction to buy.'" "Well, here's what it felt like, right? And it didn't feel very good, right? And it was more than a 10% correction in the NASDAQ [Composite Index], for example.

Lee: I'd add one thing.

Rocco: Go ahead, Rob--

Lee: Quickly, to the extent that tariffs came in harder and faster and bigger than people expected, those were created by policy, a second Trump administration. And on the campaign trail, as Steve said, he was pretty transparent. "Tariffs is the most beautiful word in the English language."

You knew he had a belief in this. It just surprised on the high, bold, earlier side. But to the extent that it was policy, it could be reversed or at least dialed back some. In the sense that it was man- (and mostly men in this case), man-created, you could unwind that or ease off. And that's kind of what we've seen.

Rocco: Yeah. That's a good point, Rob. I don't think the market ever lost hope in that, actually. And it turned out to be true, where obviously the administration backed off, and that's why at points in time you saw recession probabilities move up to 70%, 80%, but you didn't see high-yield spreads move up to recessionary levels.

You didn't see IG [investment-grade bond] spreads move up to recessionary levels. And in a recession, I would expect (the average recession), stocks draw down [decline] 30%. So, I don't think the market ever fully priced the worst of it. And there was obviously some belief that there would've been a reversal and that's proven to be true at this point in time. Obviously, things can change quickly here, right? We know that. But that I think is something to consider as well.

D’Souza: What about the Fed [U.S. Federal Reserve]? So, you talked earlier about there being a slowdown in growth maybe even going into the pre-tariff announcements, and some of these expectations of inflation kind of challenging, I guess, Jay Powell and the rest of the FOMC [the policy-setting Federal Open Market Committee]. What are your thoughts on sort of how they navigate going forward here, and anything changed in your mind?

Rocco: Well, I would tell you recently the market was pricing in a June cut and maybe three or four cuts this year. That's backed off here now with the latest news and you're pricing in two cuts. I know, obviously, the Trump administration and President Trump himself wants the Fed to cut.

D’Souza: That's clear.

Rocco: He's very clear. My personal belief (and given the level of uncertainty that we're talking about here and they want to see how the policy plays through), I think it was right for them to actually hold where they are right now. And then once they get more certainty on it, then they can move forward and formulate a plan for what the next steps would be, whether it's to continue to hold or to cut.

And obviously now they have a dual mandate, right? And the labor market here (and as we talk about this hard date, right), labor market's been okay, been actually okay and pretty strong, weakening in spots but still somewhat healthy, I would argue.

And tariffs, as we know, are stagflationary, right? So, you have that inflation piece and that inflation mandate. So, I'm not surprised they're concerned about that inflation piece. I think the good news is inflation expectations throughout this period-- now, this is another one where you have the survey data--if you look at the Michigan survey, a lot of consumer surveys of inflation expectations, it's off the charts. And the Fed itself has dismissed that. They kind of look one-year-forward or three-year-forward inflation expectations. But if you look at actual CPI swaps, or the TIPS market, you don't see that. So, inflation expectations have been relatively anchored. I think the Fed is--

D’Souza: Hard data.

Rocco: Yeah, it's a soft versus hard data. And I think there's some emotion probably in the soft data as well, depending on who you're surveying, right? It's a very emotional time. So, I think that's probably a good thing. I will say that one thing on the Fed is if the data does weaken, they will respond. And if hard data weakens, they will respond, especially if the labor data weakens.

We haven't seen that. You haven't seen it in jobless claims. You haven't seen it in payrolls. But they will respond if it does. And now at this point in time, we have to consider the second part, right? The second part can be-- it's an extension of the tax cuts [enacted in 2017] and they're going through that process now, the budget reconciliation.

It could be more, right? It could be more fiscal [stimulus], right? And I think also, something we haven't talked about yet, was DOGE [U.S. Department of Government Efficiency], right? And I think that's kind of gone by the wayside a little bit, right, if you think about coming in, cutting the deficit. There were some cuts, we're talking about $165 billion, and we didn't touch the major things when it comes to actually reducing the deficit, like Social Security, Medicare, Medicaid and such, defense spending, what have you.

So, it looks like deficits will stay high here. And you're running up such a big fiscal deficit, that in itself is, I would argue, stimulative and inflationary as well, especially if you don't get all the DOGE cuts that were promised. It doesn't look like we're cutting a trillion [in government spending], as one example.

So that's something kind on the go-forward, and I think that's why we've seen the curve behave the way it's behaved. That's why you see the term premium increase. You've seen, you know, even in this period not as big a drop in rates as you would expect on the back end [of the yield curve].

On the front end you have, because in the front end, as the curve has steepened, you actually have a pretty good hedge for something worse in weaker data. But on the back end, you've seen that's steepening, and that plays into some of the non-U.S. markets I talk about where you have more stimulus there and you have more Europe rates and it's a global market and European rates are steepening as well, the European rates markets. And that's probably on the back of what we see there is more fiscal expansion and better growth.

D’Souza: Yeah, we've seen some dramatic moves in the shape of the yield curve and the shifts in the front end and long end. Rob, I know you're obviously a close Fed watcher and the yield curve. What are your thoughts on that overall?

Lee: Okay. So, first, let me make a few comments about the Fed--and perspective matters here. So going back to 2022 and 2023, the Fed started hiking in March 2022 and stopped hiking rates for the Fed funds rate target in July 2023. They hiked, in less than a year and a half, 525 basis points.

They were fighting inflation [which] got really high. Everybody remembers it. We're not going to forget it for some time. Since then, and in September to December of last year, not that long ago, the Fed started reversing those hikes and cut 100 basis points in a total of three meetings in roughly three months.

Kind of the early cuts, they believed that the monetary policy was in restrictive territory, and they made an early down payment on supporting the economy and taking off some of that very tight monetary policy as they saw it. Since then, they've paused.

And I’ll tell you why they've paused. They've paused because they're in a very difficult place, difficult place because, as Steve mentioned, tariffs are stagflationary or at least they provide stagflationary impulses. Doesn't guarantee that it'll lead to actual stagflation, but they provide stagflationary impulses.

The reason that makes it difficult for the Fed is, as Steve said, they have a dual mandate. One side of the mandate is maximum employment, and the “stag” part of stagflation is stagnation so if you get stagnation (higher recession probabilities, weaker economy), that's bad for the labor market so it would argue that they should cut.

But the “flation” part of stagflation refers to inflation and higher tariffs are a tax and put upward pressure on prices, all else being equal. And higher inflation means, in isolation, the Fed should hike. So, when I say then a hard and difficult decision and place on one side they should cut, on one side they should hike, depending on what side of the dual mandate you look at.

What makes it even harder is policy keeps changing. This is 90-day delay on tariffs, this is Liberation Day, this is a deal with China, this is maybe more sectoral tariffs coming in, sectoral meaning lumber and semiconductors and pharmaceuticals and maybe copper--remains to be seen.

The policy's changing often enough in the first 100-plus days of the Trump administration that it pays for the Fed--and Chairman Powell said this--"Let's just hold, wait and see. We need to see how this evolves," both the actual economic data and the actual policy coming out of the Trump administration.

Last thing I'd say and then we can pause and talk about the yield curve is Steve is 100% right. What is very possible and probably likely is if you go through the chronology of 2025, early in the year the Trump administration provides the medicine (nobody likes to take the medicine), and that's the tariffs because they're trying to engender change in global trade and fairness and things like that and manufacturing coming back to the U.S.

But the candy may be coming in the second half of the year. The candy is, "Okay, President Trump campaigned on lots of fiscal changes, including things like no tax on tips, no tax on overtime, no tax on Social Security benefits, auto loan interest deductibility, various other things."

Whether we'll get all that or not remains to be seen. But the candy may be coming in the extension of most of the [2017] Tax Cut and Jobs Act provisions that are due to sunset at the end of 2025, plus maybe some additional candy, some of those things that I mentioned.

And it remains to be seen whether they can get that done. And if they do and there's net fiscal stimulus, meaning a boost to the economy, net spending by the government, that makes it harder for the Fed to move until they see more clarity on that.

D’Souza: Are you saying in a sense we could still get a soft landing, just a bumpy approach?

Lee: The short answer is “absolutely yes.” Remember this: in 2022, everybody thought because of aggressive rate hikes in 2022 and 2023, they thought there was a high probability of recession and, as I like to say, who could blame them? When the Fed hikes that aggressively it usually slows the economy down and there's pain.

The resiliency of the American economy, and largely the U.S. consumer, quite frankly in the last few years, has been phenomenal. And it's quite possible that all the tariffs, including the back and forth and the actual effect, the strength of the U.S. economy's enough-- it would probably soften, and you saw that in first quarter GDP, will probably have some impact on the second quarter GDP, but it's possible to get no recession. It's always possible. And if we do get net fiscal stimulus, well, that makes it even less likely you get a recession.

Rocco: The data has kind of supported that in the first quarter. Maybe you argue that growth was a little bit weaker than one would consider a soft landing, but that's on payback from Q3, Q4 [of 2024], which were very strong. And there were some weather effects in January as well.

So, I think in the absence of all the tariff and the headlines I think that it would've felt very much like a soft landing at this moment in time. Now, I think if you're going to stick with a certain level of tariff, as I said, that's better than the market expected and that's what matters, expectation, there's still a level of tariff though that's somewhat of a tax, right, and somewhat disruptive to the supply chain and somewhat inflationary.

And then if you get more fiscal stimulus on top of what you already have, it may be harder for the inflation data to stay kind of where it is. You may see that gradual uptick and that probably wouldn't feel as much like a soft landing. You may get inflation above the Fed target in the back half [of 2025]. Whereas in the first half it's been moving right towards the target quite nicely.

D’Souza: Yeah, so a lotta response I guess in the marketplace to the initial announcement of the tariffs was that knee-jerk emotional like, "There goes the soft landing, right? It's over," and the market kind of--

Rocco: And very rational too because what Rob's mentioned-- 24 percentage points of tariffs--I'm confident that would've caused a recession if it stuck. I don't think that's heroic to say that, but it's an extreme tax on the U.S. consumer.

D’Souza: But since it's kind of may be calming down a bit now and if this plays out the way you're talking about, Rob, where it's basically medicine up front and candy in the back half of the year, there's a soft landing--

Rocco: Yeah--

D’Souza: --and it's just a bumpy ride--

Rocco: --and this is what the administration talks about, right? I think you were with me at Milken [the 2025 Milken Institute Global Conference] where [U.S. Treasury Secretary Scott] Bessent was talking, and this is what he laid out in three parts, right? He laid out that you can't just think of tariffs, you think of tariffs, you can think of taxes, think of the deregulation piece. Think of all three parts. And the last two are the candy. And we may be moving to the candy phase, right? So that's a good thing, right? And I think that's potentially a good thing. Go ahead, Rob.

Lee: I will draw one analogy. So, the first Trump term, which started in 2017, you had the opposite order. The opposite order was where you got the 2017 Tax Cut and Jobs Act, which is net stimulative to the economy, and that was the candy up front.

And then the tariffs, although they were working on it throughout 2017, came late 2017 into 2018. This time it was the reverse of that order. So, it was candy/medicine in the first Trump term and now it's medicine and candy and maybe there's room for optimism.

D’Souza: I feel like I'm home right now with my kids talking about candy and medicine. This is great. So, let's go a little deeper into the actual segments of the market that you guys cover, more specifically in terms of high-quality fixed income and leveraged credit. So, Rob, talk about how you're thinking about high-quality fixed income these days with the shape of the yield curve, everything we're talking about.

Lee: Sure. Okay. So first, let's talk about the shape of the yield curve. The yield curve was very inverted a year or two ago, very inverted. So, this is the slope of the difference in yield between two- and 10-year maturities, the slope between two- and 30-year maturities. Depending on what you're talking about, it got to negative 100 [basis points]. Very inverted.

And if remember all the discussion back then, inverted curves don't cause, but often are followed by, recessions. It didn't happen. Now the curve is positively slope, as Steve mentioned the curve has disinverted and now it is positively sloped.

So, I'll give you some very rough numbers. It could change at any moment. But sitting here right now the two-year [note yield] is around 4%, the 10-year's around 4.5%, and the 30-year is around 5%. I'm doing very rough numbers. So, the two/30 [yield curve] slope is plus 100 basis points.

When you look at the long history (I'm talking about 25, 30 years average, I'm using quarterly data, so it smooths a lot of this), that's not that atypical, depending on what timeframe you look at. It's not egregiously far off the average slope of two/30s.

So that's worth noting. We generally believe in steepeners but less certain now, given some of the good outcome in the dialing back of tariffs. We can talk more about that, but the curve could steepen a lot for reasons I can go into.

But I would say that, broadly speaking, when I take the big step back my view is that there's enough uncertainty around all this, all the policy changes, with the understanding that Trump is not afraid to go big and bold.

And that elicits change in the world. I don't want to overstate it, but there is some meaningful change in the global trade architecture. There is some meaningful change in geopolitics. And Steve mentioned this, but Germany is spending on defense and doing fiscal stimulus on defense and other things because they are less certain (Europe is less certain), that the U.S. is going to provide enough support for Ukraine or the security umbrella, including the nuclear umbrella, for different parts of the world.

I think there is enough change going on (fiscal policy is another that we just talked about), that when you really take the step back there's a fair amount of uncertainty. It doesn't mean we don't have a view. I can give you our view, or mine certainly, or Steve can give you his.

It means in my view for high quality portfolios you want to be prudent. There are still good things to buy, and we can talk about it, but you don't want to be too heroic in your positioning in any one dimension. You also want to be nimble to take advantage of opportunities. So let me talk about some of those.

So, because of what happened in April, spreads widened in every non-treasury sector pretty much. They've come back some as the tariff news has gotten more positive or has at least inflected less negative. But spreads are more attractive. And that's true for investment-grade corporates.

I'll give you an example here. Investment-grade corporates are a big, large, prominent sector of the bond market. Depending on what index you use, [the yield spread] went from roughly 80 basis points over Treasuries at the index level to roughly 120. And now we're back to 100 or 95, in that range.

So spreads are wider than the tightest levels at the start of 2025, definitely off the peak widest level. But if you look at a 20-year average or a 30-year average you're talking about the average as 130 basis points. So, a little bit tighter than that but more attractive spreads now than certainly when it was 80 basis points earlier this year.

And make no mistake, we find some very good opportunities in investment-grade corporates. Some are on the shorter end of the yield curve, some are in utilities, which we believe have lots of secular tailwinds, including spend on AI and the need for power generation and broader electrification trends in the country and the world.

There are things in consumer staples where if there is a recession you're going to be fine. I'm not saying that the prices and spreads won't move. I'm just saying you have very, very strong corporate fundamentals and very, very robust balance sheets and income statements.

And then another theme might be services over goods. If goods are the ones that are getting tariffed, certain names in technology (as one example), are very insulated from that, and also have secular tailwinds. Think some of the big, I mean giant, semiconductor companies with a tremendous amount of intellectual property and real assets.

So, you could buy more attractive spreads, and that's just one of many sectors that we're looking at. The second example I would give is some of the real estate related sectors of the bond market we are leaning into. So commercial mortgage-backed securities had their pain.

The Fed hiked a lot in 2022 and 2023, and commercial mortgage-backed securities and commercial real estate had a lot of pain. And when that happens it doesn't mean they can't have pain again. It means usually the underwriting is really strong, the collateral and the loans behind this and the buildings behind the new issuance are pretty pristine, and you're starting off at higher interest rates and cap rates so you can find attractive things in commercial mortgage-backed securities and in residential mortgage-backed securities too. So that's where we're finding opportunities right now.

D’Souza: Gotcha. And you mentioned spreads in there and especially in the IG corporate world. So going deeper into the world of spreads I guess, Steve, in leveraged credit, where are you seeing opportunities and/or “canaries in the coal mine”. What are you seeing in leveraged credit these days--

Rocco: Well, it looks like nothing's happened this year because spreads are exactly where they started the year.

D’Souza: Nothing to see here.

Rocco: Yeah. For high yield, I think they started the year, and we tightened, obviously, and then we've widened to probably about 450 [basis-point] spread. We're talking about high yield spread. And now we're back to inside of 300. Now, to put that into context, the average post-COVID spread is around 430. We got above-average in April and now we're quickly right back down. I think the high-yield market is (and I've said this many, many times), a very resilient market for a lot of reasons.

And I think it's proven its resiliency. In a recession, and I was touching on this, right, a high yield will trade anywhere from 900 to 1,000 [basis points in spread] in a recession. And I talked about the fact that we priced in a 70% probability of recession, and high yield had trouble breaking 500.

And we got between 400 and 500. We saw a lot of crossover buyers [those who do not typically participate in leveraged credit]. We saw a lot of buyers, including ourselves, very interested in buying high yield at those levels and those yields, right? Because now, remember, we're not dealing with 4% high yield anymore. We actually have a spread over a Treasuries that's elevated.

So, you're getting 7%, 8%, 9% type yields. So, if you look at the resiliency of high yield, the credit quality is exceptionally strong with the double-Bs [“BB”-rated bonds]. The duration is exceptionally low, all-time low. That matters when you're calculating your spread.

The percentage of secured bonds over unsecured is at an all-time high. So, I think at every level the high yield market is pretty clean. You actually see it too, we talk about growth slowing down, right? The default rate in high-yield, obviously backward-looking, is sub-50 basis points right now [based on JP Morgan data]. That's an all-time low.

And it's really hard from the bottom up to get to a default number that's higher than 3%. If I look at it from each individual constituent in the high yield index [ICE BofA U.S. High Yield Index] and say, "That will default, this will default." There are not a lot of areas where I would consider to have a lot of stress from that standpoint.

And so, if you think about what you earn in high yield, you earn in excess spread, usually between 250 and 300 basis points over your default loss. And I think your average recovery in high yield [recovery by creditors of defaulted amounts] is usually around 40 cents on the dollar so if you think about that 2%-3% default number, if that's your base case moving forward, your default loss would be somewhat de minimis [insignificant].

And you can earn that excess spread, and you're talking about a starting yield of 8% or 7.5%. and so, you have a high conviction that you're going to earn that yield, and that's a pretty nice return when you compare it to long-term average equity return.

So, I think high yield’s been pretty resilient. And we always tell our investors, "You have to stay in the game with high yield, right? It's very hard to trade it." I will tell you these moves have been quite rapid, right? It's one day you're at 450 and two days later you're at 300 and there's very little trading in between.

So, I think it pays to stay invested. Now, last year I talked about the fact that we were in a higher nominal growth environment. You can tell by my comments here I think that's changed. The back half [of 2025] will be interesting. But in that environment, you want to focus more on quality.

So less of a triple-C [“CCC”-rated bonds] opportunity. Now, if you look at triple-C performance they severely underperformed in the first quarter. They've come back, but they're still 100 [basis points] wider on the year. So, while markets are “risk-on” [more willing to assume investment risk] at this moment, you expect some level of compression.

But triple-Cs need that higher nominal environment to kind of fully get back to where they need to be. So, we've been emphasizing more quality and balance in our portfolio. And then also what Rob's pointed out too, in a tighter spread environment and given the level of uncertainty, not just on tariffs but there's also sector-level uncertainty, right, you see what's happened in health care.

You look at a company like UnitedHealthcare and potential cuts in Medicare, Medicaid, and all these things that can happen that the administration could be focused on next, and you look at the oil market as well, right? You've seen potentially a supply problem, maybe even a demand problem as well. I think it pays to not take large sector bets and kind of keep it close to home. I think, if anything, we're shifting a little bit more defensive or cyclicality, depending on the environment.

I think we leaned a little more into cyclicality when things were wider, but now that things are tighter it's closer to home. And the same is true on the ratings side. So, we brought down our triple-Cs considerably in the first quarter. And that wasn't really a response to tariffs, although tariffs exacerbated the move.

It was more the fact that growth was slowing despite the tariff news. So that's high yield. Bank loans we've talked about clearly will ebb and flow based on the duration environment in terms of what you earn. Here you have credit quality that's a lot worse than high yield when you're talking about now single-B [credit quality], a lot more in the way of sponsor-led deals as well and a lot more, I would say, pockets of stress down in quality than you would in regular way high-yield, not to say there isn't an opportunity in bank loans.

The big thing with bank loans is always the big buyer is not [a manager like] us. It's not mutual funds. It's CLOs [collateralized loan obligations]. There I would say the arb [arbitrage opportunity] has shrunk a little bit. You remember in bank loans there's been a big repricing. There was a big repricing wave to start the year, and then you had liability spreads step up.

Now you have liability spreads coming back down again. You're starting to see the CLO machine get going. That'll be beneficial to most of the bank loan market, I think. But the challenge of the bank loan market is that the CLO is not the natural buyer of distress.

So, while there are pockets of opportunity there for an active manager or a hedge fund, what have you, I think that's something you wouldn't see a CLO do. But you can see that demand environment pick up as the arb improves. And I think we're starting to see that.

But more, if you're worried about a recession, I think you'd worry more about that asset class than you would high yield. I won't get into private credit today unless you want to, but those are the two pockets of leveraged credit that we invest in on the public side and how they compare and contrast.

D’Souza: No, that's great. Thank you. So, we've gone through a lot here. I'm going to see if I can summarize some of the points you guys made and see if this makes sense. And keep me honest if I miss something here. Sounds like what we're saying today is we came into the year, as you mentioned, on our podcast in January, pretty strong fundamentals, both on the corporate side and the consumer side.

The tariffs were a surprise in magnitude and timing for sure, although not completely out of nowhere. And we're closer maybe to a resolution than we are not on the tariffs, which would be maybe a calming force in the market, perhaps. We talked about the idea of this is part of the medicine up front versus the candy later in the year and that concept overall, which is interesting.

We spoke about the Fed, and there's still a chance here to maybe engineer a soft landing through all the noise we've had this year, which is encouraging, I think, to a lot of people overall. And then in terms of individual areas of opportunity, with the yield curve now being positively sloped and a little more clarity, again, on some of these policies potentially here, it sounds like in high-quality fixed income, Rob, you're seeing opportunities in areas like IG corporates, where spreads are in from their wide but still higher than pre-tariff days and other areas, like utilities and consumer staples, also look pretty good to you overall.

Steve, when it comes to high yield, again, if you kind of fell asleep and woke up you'd say nothing really happened, but under the surface during the last couple months there's been a lot of action in high yield spreads. They've moved quite a bit but back to somewhat more, I guess, normal levels now, if you will.

But again, staying nimble and staying liquid in this market's probably most important to kind of use your words there. And to use both of your comments here, in both areas, both high-quality and in leveraged credit, there's definitely opportunities at the margin and in certain sectors but nothing heroic to be done here at this point as we kind of go forward slowly, watch for the soft versus the hard data and see what the market gives us going into the second half of the year.

I know that the news out there has been pretty crazy and it's a lot of noise, but talking to both of you again today gives me comfort. And so, thank you for sitting down with us today and going through all the noise and finding what the signal is and where the opportunities are in the marketplace. We appreciate it, guys.

Rocco: Thank you, Andy.

Lee: Thank you.

D’Souza: All right. Thank you. It's always a pleasure. This has been The Investment Conversation podcast. Thanks again for tuning in.