A New Regime of Rates Ushers in New Opportunities

CIO Letter: A New Regime of Rates Ushers in New Opportunities

Time to read: Minutes
Matt Toms

Matt Toms, CFA

Global Chief Investment Officer

Key Takeaways

Rate hikes bring us back to normal: The recent rise in rates, while dramatic, represents a return of the U.S. 10-year real yield to its long-term average.

Real yields can persist at elevated levels: The return of real yields to long-term averages (while painful) is making fixed income investing easier and more attractive.

Tight labor markets are helping support higher yields: In the short term, we expect the shortage in labor markets to continue to support wages, but longer term, we expect corporations to invest more in AI, robotics and automation.

When you start at zero, current rates can seem high (and unsustainable), but history shows the market is reverting back to average.

2023 marks the return to a normal rate environment

After a decade of “easy money,” zero rates may feel like a baseline, but historical data tells a different story. Markets have a long history of distinct real yield regimes. Understanding how we got here can put recent volatility in perspective and help inform where we are headed (Exhibit 1).

Exhibit 1. U.S. real yield returns to long-term average
10yr U.S. TIPS yield and federal funds rate (FFR) ranges
Exhibit 1. U.S. real yield returns to long-term average

As of 09/30/23. Source: Bloomberg Index Services Ltd., Voya IM.

1990s: Inflation fears and the beginning of globalization. The U.S. 10-year real rate averaged roughly 3.5%, with the Federal Reserve maintaining the fed funds range of 3.0–6.5%. This period was marked by concerns that included a growing U.S. deficit, fears of decreasing U.S. competitiveness on the global stage and residual apprehensions about inflation still left over from the 70s and 80s.

Early 2000s: The rise of globalization and emerging markets. In the early 2000s, as the dotcom bubble burst, there was a noticeable drop in real rates to an average of 2%, while the Fed moved rates from 1.0% in 2004 to 5.5% in 2006. Key driving forces during this period included globalization the widespread embrace of technology, and the disinflationary effects caused by the growth of emerging market economies. The integration of emerging markets into the world economy introduced a vast and relatively low-cost labor force into global supply chains. As multinational corporations shifted production to emerging markets to take advantage of these cost savings, it put downward pressure on wages elsewhere, especially in more developed economies. The tail end of this era kicked off the move to zero rates, as the excessive leverage that fueled the U.S. housing boom and collapse culminated in the 2007–08 financial crisis.

Post 2008 crisis: Lower for longer ushers in decade of zero rates. After the financial crisis, the world experienced almost a decade of zero to negative real rates. One of the main takeaways from this phase is that a consistent zero rate isn’t historically the norm. The real average interest rate over extended periods paints a more fluctuating picture.

Exhibit 2. Corporate yields’ current advantage over equities is not unprecedented
Exhibit 2. Corporate yields’ current advantage over equities is not unprecedented

As of 09/30/23. Source: Bloomberg Index Services Ltd., Voya IM. SPX: S&P 500 market-cap-weighted index. SPW: S&P 500 equal-weighted index.

Now, we’re on a journey away from an abnormal regime of prolonged, aggressively stimulative fiscal and monetary policies. We no longer need the emergency measures of the global financial crisis or to help the economy through Covid. While this journey has introduced significant volatility in bonds markets, we believe the current destination is a healthier investment environment than any we’ve experienced since pre-2000: positive real yields, reasonable price-to-earnings ratios, less dependence on fiscal and monetary policy, and less reliance on emerging market growth. Plus, for the first time in 15 years, fixed income is a competitive asset class again. It’s also worth noting that stocks and bonds did well together in periods of previous higher rate regimes.

So—reiterating our message from April—fear the volatility, but don’t fear the destination.

Voya IM economic forecast

Inflation lingers …

U.S. inflation run rate continues to fall but remains above the Fed’s 2% target in 2024.

because of resilient labor markets …

Unemployment rate remains near lows, wages remain steady.

… causing the Fed to keep rates higher for longer

We think the discussion on rate increases has run its course and investors should focus on how long the Fed might maintain official rates— cuts only materialize when labor conditions deteriorate or if something “breaks.”

Can real yields persist at these levels?

The short answer is yes, we believe real rates can sustain current levels. The Fed will likely be hesitant to cut rates until either inflation reaches its 2% benchmark or there’s a significant dip in employment.

Despite recent challenges and volatility, the bond market offers attractive yields, especially when compared to the zero-interest rate environment during the pandemic. The good news for investors is that you don’t have to reach down in credit quality to generate attractive yield. Investment-grade corporate bonds are delivering yields above 6%.

The increase in corporate bond yields has also drawn attention from equity markets. Exhibit 2 is another illustration that the most recent decade of ultra-low rates was a deviation from the norm. Following the 2008 crisis, corporate bond yields (orange line) stayed well below the earnings yield on the S&P 500 (blue line). This dispersion was largely due to the dip in real yields, which is represented by the brown line at the bottom of Exhibit 2. Corporate yields are now higher than the S&P 500’s earnings yield, reestablishing a level that is more in line with its history. Higher corporate yields should attract more investors to the asset class, helping bring additional stability to the bond market.

Of course, one of the main reasons why real yields have persisted at higher levels is the tight labor market. In the short term, we expect the shortage in labor markets to continue to support wages. However, the corporate response to this labor shortage is going to be more investment in artificial intelligence, robotics and automation spanning every industry—including asset management.

Speaking of AI in asset management…

The financial world’s enthusiastic embrace of AI has been one of 2023’s biggest stories. But a lot of the industry talk so far has been “aspirational,” so it’s nice to have something tangible to present.

This summer, the team behind Voya Machine Intelligence (VMI)—which has been pioneering AI-driven investing for over a decade—celebrated a key milestone for its flagship strategy. In the three years since inception in 2020, the Opportunistic U.S. Equity Strategy beat the S&P 500 by 9.4% annually (8.6% net), putting it in the top 2% of its peers.1 What’s all the more impressive is that it did so despite (ironically) being underexposed to the AI trade in 2023.

While it is still early days for AI adoption in asset management, we believe the potential opportunity for investors is enormous. For example, our machine-driven portfolios often move away from crowded trades due to their unique investment process, providing diversifying return streams in a world of highly concentrated benchmarks. We’ll have a lot more to say around this exciting field as our equity platform continues to enhance the value we offer our clients.

Voya MI Opportunistic U.S. Equity performance, since inception (SI) on 8/01/20
Voya MI Opportunistic U.S. Equity performance, since inception (SI) on 8/01/20

As of 07/31/23. Source: Voya IM. Past performance does not guarantee future results. Figures may not sum due to rounding. Gross and net performance numbers based on unaudited returns. Composite represents the investment results of a group of fully discretionary portfolios managed according to the Strategy. Returns include the reinvestment of income. Gross returns are presented after transaction costs, but before management fees, which, in addition to other fees incurred in the management of the portfolio, would further reduce returns. For a description of advisory fees, please see Form ADV, Part II. Gross returns should be used as Supplemental Information only. See back page for additional disclosures

Risks of investing

All investing involves risks of fluctuating prices and the uncertainties of rates of return and yield inherent in investing. Foreign Investing does pose special risks including currency fluctuation, economic and political risks not found in investments that are solely domestic. The Voya MI Opportunistic U.S. Equity Strategy may use Derivatives, such as options and futures, which can be illiquid, may disproportionately increase losses and have a potentially large impact on Strategy’s performance. Other risks of the Voya MI Opportunistic U.S. Equity Strategy include but are not limited to: Company; Currency; Growth Investing; Investment Model; Liquidity; Market; Other Investment Companies Risks; Price Volatility; Real Estate Companies and Real Estate Investment Trusts (“REITs”); Securities Lending and Value Investing Risks. All investments in bonds are subject to market risks as well as issuer, credit, prepayment, extension, and other risks. The value of an investment is not guaranteed and will fluctuate. Market risk is the risk that securities may decline in value due to factors affecting the securities markets or particular industries. Bonds have fixed principal and return if held to maturity but may fluctuate in the interim. Generally, when interest rates rise, bond prices fall. Bonds with longer maturities tend to be more sensitive to changes in interest rates. Issuer risk is the risk that the value of a security may decline for reasons specific to the issuer, such as changes in its financial condition.


1 eVestment U.S. All Cap Equity peer group 3-year gross performance as of 07/31/23, based on 220 of 387 strategies in the category that provided intra-quarter data as of 08/29/23.

Past performance does not guarantee future results. This market insight has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations and (6) changes in the policies of governments and/or regulatory authorities. The opinions, views and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change based on market conditions and other factors.