Recent VIX rise does not mean there will be problems for lenders: UBS By Investing.com

Investing.com – The recent rise in the VIX sparked debate over whether the popular “fear index” is a signal of a potential credit event or a warning of widening credit spreads. However, UBS says credit markets are still heading for a “soft” landing.

“Based on historical analysis and the context of this VIX spike, we believe the answer is no, and we continue to expect a rather soft landing for credit,” UBS said in a note amid the recent debate over whether the VIX spike indicates problems in the credit business.

The VIX rose above 65 on August 5, its highest level since March 2020, when recession fears sparked a massive sell-off. This rise in the VIX did not trigger a widening of credit spreads compared to the past, reinforcing UBS's view that the rise was not a death knell for credit.

In the last nine episodes since 1990 when weekly VIX peaks were above 20, median investment grade bond spreads widened significantly less, initially by about 6 basis points or bps compared to 18 bps this time. But they widened further thereafter, by about 14 compared to this episode, when spreads largely recouped losses, UBS added.

Since the August 5 volatility event, the VIX has plummeted to 14.65, suggesting that the recent rise was more technical than fundamental.

This time, the VIX increase was “more technical than fundamental. First, strong growth in trading in short-term options and yield-enhancing structured products dampened volatility before the increase, and during the increase it was the other way around,” UBS explained.

The move was also exacerbated by “poor liquidity in pre-market SPX options and traders' hedging activity on the VIX call optionality” as well as “the unwinding of the G10 carry trade that spilled over into the equity and derivatives markets,” it said.

For 2024, UBS maintained its US spread targets, including 95 basis points for investment grade and 325 basis points for high yield, but adjusted the third quarter expected ranges to 90-105 basis points for IG and 300-350 basis points for high yield.

“We view recent data as support for our forecast of a softer credit landing. Initial jobless claims, building permits and net sentiment numbers did not change our indicator of the health of US consumer credit (Z-score unchanged at +0.3). It is close to weaker post-COVID readings but not recessionary,” it added.