Voya High Yield SMA Quarterly Commentary - 3Q26

A range of developments during the third quarter of 2026 underscored the resilience of economic growth while reinforcing concerns that inflation would remain elevated: the labor market appeared to have rebounded from the weakness in 2025, inflation proved more persistent than expected, geopolitical disruptions tied to Iran continued, and artificial intelligence remained an increasingly powerful influence on both economic activity and capital markets. Despite concerns that higher energy prices and elevated interest rates would slow growth, the U.S. economy remained remarkably resilient. Payroll growth continued throughout the quarter, unemployment remained relatively low, and broader economic activity held up better than many anticipated. 

Inflation remained the dominant macroeconomic challenge. Headline measures were heavily influenced by the war in Iran and ongoing disruptions to energy markets, which periodically pushed oil prices higher and renewed concerns about commodity-driven inflation. Yet the more important development for fixed income investors was the persistence of underlying inflation pressures. While shelter inflation continued to moderate and wage growth remained contained, strong demand associated with resilient economic growth coupled with the continuing AI investment boom kept core inflation stubbornly elevated. As a result, markets increasingly converged around the view that inflation was likely to remain closer to 3% than the Federal Reserve’s 2% target. 

Expectations for monetary policy evolved alongside these dynamics. From the outset, Fed Chair Kevin Warsh sought to reinforce the institution’s credibility by emphasizing the Fed’s commitment to restoring inflation to its 2% target. And despite reducing the degree of forward guidance provided to markets, Warsh’s speeches repeatedly generated outsized moves across the Treasury curve, including in a notably hawkish message at Jackson Hole. Markets interpreted the speech as a clear signal that additional tightening was likely, leading rate-hike expectations to rise sharply. By their September meeting, markets had largely priced in a hike, and the Fed ultimately delivered one. 

The front end of the Treasury curve reflected these shifting expectations, resulting in higher short-dated yields. The long end faced a broader set of influences. Resilient growth, sticky inflation, persistent fiscal deficits, and the financing demands associated with the AI investment cycle all contributed to upward pressure on longer-term yields. The move in yields caught the attention of Treasury Secretary Bessent, who announced an increase in the size of Treasury buybacks. However, even after the increase, the size of the program ultimately did little to materially influence the direction of yields. By quarter-end, yields across the curve sat near the highest levels seen in years. 

For most of the quarter, credit markets proved remarkably resilient. Within corporate credit, investment-grade spreads remained near historically compressed levels despite heavy issuance related to AI-related investments. Within securitized markets, CMBS fundamental factors continued to improve, although higher rates and heavy issuance created a headwind. Non-agency RMBS continued to be supported by a resilient housing market and generally stable collateral performance. Agency MBS was the outlier given headwinds from elevated rate volatility. As a result, the selloff in rates eventually bled over to credit, leading spreads to widen modestly in the final days of the quarter. As a result, most fixed income sectors delivered negative results, on both a total and excess return basis.

For the quarter, the SMA outperformed the Index on a gross-of-fees basis, but underperformed on a net-of-fees basis. Gross-of-fees, outperformance was driven by the SMA’s higher quality focus, as higher-quality bonds outperformed during the period, with the CCC-rated portion of the high yield market underperforming.

The U.S. economy continues to expand near trend, but the sources of growth are becoming narrower. AI investment, fiscal support, and spending by higher-income households remain durable tailwinds in the near term, but unsustainable in the long term. AI capital spending cannot grow at its current pace indefinitely, although strong hyperscaler balance sheets, committed projects and relatively rate-insensitive demand make a meaningful slowdown unlikely over the next several years. Fiscal deficits also appear unlikely to narrow soon, even as rising interest costs underscore that the current trajectory is unsustainable. Consumer spending is similarly bifurcated: wealth effects continue to support higher-income households, while cumulative inflation, borrowing costs, and slower real income growth are pressuring lower-and middle-income consumers. 

AI remains one of the more interesting dynamics, given its impact on both the growth and inflation outlook. The buildout of AI capabilities should continue to support capital spending and corporate earnings. However, this demand is colliding with physical constraints in electricity, grid capacity, materials, specialized labor, and advanced chips. This imbalance also makes the economy less responsive to monetary policy: higher rates can restrain consumers, housing and rate-sensitive businesses, but they cannot quickly expand power supply, accelerate chip production or reverse commodity and supply-chain disruptions. 

The Fed’s September rate increase therefore looks more like a recalibration than the start of an aggressive inflation-fighting campaign. The economy proved stronger, unemployment lower, and inflation firmer than policymakers anticipated when they delivered 75 basis points (bp) of insurance cuts this time last year. Chair Warsh’s hawkish Jackson Hole message and emphasis on the Fed’s commitment to its 2% inflation target made some reversal of that accommodation likely. Our base case is for two additional 25 bp hikes, effectively removing those earlier cuts rather than pushing policy deeply restrictive. 

Inflation should moderate at the margin as shelter pressures ease, wage growth normalizes and earlier tariff effects fade, but a quick return to 2% remains unlikely. Supply disruptions, geopolitical risks, elevated energy costs and AI-related demand could keep inflation closer to 3%, while resilient spending among higher-income households adds another layer of persistence. Importantly, labor market dynamics and a slower pace of wage growth reduce the risk of a wage-price spiral that would typically force a prolonged tightening cycle. The more likely outcome is a cautious, data-dependent Fed that pauses between moves while assessing inflation, employment and financial conditions. Reduced forward guidance will keep markets sensitive to each economic release. 

For fixed income investors, higher yields provide a more attractive starting point and a meaningful cushion against volatility. Yields near their highest levels since the global financial crisis continue to attract income-oriented buyers, even as tight spreads argue against broad risk taking. We favor measured duration exposure, as the market has priced in more tightening than what we think the Fed will ultimately deliver. Within credit, carry is likely to drive returns rather than further spread compression. We remain selective in corporate credit, favoring higher-quality issuers, resilient balance sheets and beneficiaries of infrastructure spending. Overall, the combination of attractive income, uneven growth, and elevated volatility supports a balanced approach built around quality, diversification and downside mitigation.