Recent VIX spike doesn't signal trouble ahead for credit: UBS

Investing.com -- The recent spike in the VIX sparked debate on whether the popular "fear index" was a signal for potential credit event or warning that credit spreads are set to wider, but UBS says credit is still set for 'softish' landing.

"We believe the answer is no based on historical analysis and the context of this VIX spike, and we still see a softish landing for credit," UBS said in recent note, as it weighed in on the recent debate about whether the VIX spike signals trouble ahead of credit.

The CBOE Volatility Index, or VIX, surged above 65 on Aug. 5, its highest level since March 2020 as fears about a recession sparked a major selloff. This spike in the VIX didn't spark the widening in credit spreads compared with the past, underpinning UBS' view the spike wasn't a deathknell for credit.   

In the past nine episodes since 1990 when weekly VIX spikes were greater than 20, median investment grade spreads widened much less initially about 6 basis point, or bp, vs. 18bp this time, but then widened further about 14 compared to this episode where spreads largely reversed the losses, UBS added. 

Since the volatility event on Aug. 5, the VIX has plummeted to 14.65, suggesting that the recent spike was more technically driven rather than fundamentally. 

The VIX spike was "more technically, not fundamentally, driven this time First, strong growth in short-dated options trading and yield-enhancing structured products suppressed vol going into the spike, and the reverse through the surge," UBS said.

The move was also exacerbated by "poor liquidity in SPX options pre-market and dealer hedging activity in VIX call optionality" as well as "the unwind of the G10 carry trade that spilled over into equity and derivative markets," it added.

For 2024, UBS maintained its US spread targets including investment grade 95bp, and high-yield 325, though tweaked expected ranges for Q3 for IG to a range of 90-105bps and high-yield to a range of 300-350bp. 

"We view the recent data as supportive of our softer landing view for credit; prints on initial jobless claims, housing permits, and sentiment on net have not changed our US consumer credit health gauge (z-score flat at +0.3), near weaker levels postCOVID but not recessionary, it added.