Credit’s fine. For now.

The chaos in front-end US rates that accompanied a triggered Sahm rule, a meltdown in Japanese equities and a historic spike on the VIX — all of which played out across just two sessions, on August 2 and August 5 — found STIRS pricing in more than 130bps of Fed cuts by year-end at the extremes.

To call that an overshoot would be to understate the case. It was absurd, as were calls for an emergency FOMC meeting. The S&P never even made it into correction territory, and yet a whole host of ostensibly rational people spent August 5 wailing on social media and in remarks to the mainstream financial press about the purported necessity of an immediate (i.e., inter-meeting) rate cut from Jerome Powell.

More level-headed observers were quick to note that the Fed probably wouldn’t even consider an emergency intervention unless the volatility spilled over into credit. And it did. For all of a few days. The IG widening seen across August 1, 2 and 5 (~15bps) was the most pronounced for any three-day period since SVB collapsed.

And yet, as illustrated above, spreads no sooner widened than snapped back tighter as the vol shock faded and equities (S&P futs) rallied ~500bps from the early-week panic lows to the late-week highs.

Note that the same about-face was observed in the primary market. Headed into the first full week of August, dealers expected as much as $40 billion in supply. No deals got done on Monday — for obvious reasons — suggesting events might’ve conspired to close the market temporarily, particularly in light of the prior week’s somewhat lackluster deal metrics.

By Friday, though, supply actually managed to top estimates. “After Monday’s goose egg, we thought there was next to no chance that the week would even meet projections, which also exemplifies the rapid recovery in risk tone in just three days,” BMO’s Daniel Krieter remarked.

So, where to from here? Consider the figure on the left, below, which shows the VIX versus a credit spread index optimized for macro prediction.

Note the yellow-gold annotations from SocGen’s equity derivatives team. The point is that a given disconnect between the economic signal from spreads and the VIX can sometimes be explained by the fact that relatively elevated implied equity vol doesn’t always reflect left-tail risk, but can at times reflect right-tail “risk” (i.e., market participants bidding up calls and upside optionality).

“Credit spreads and equity volatility are generally joined at the hip because they reflect risks in adjacent assets on the capital structure [but] there is a very important difference between the two,” Jitesh Kumar and Vincent Cassot wrote, before explaining that difference: “Credit as an asset class primarily has left-tail risks [whereas] equity volatility can come from both upside and downside, especially over longer horizons.”

Importantly, the right-most arrow in the second gold “Right tail vol” annotation points to the disconnect prior to last week. The other chart (on the right) spells out the self-evident: Left-tail pricing was dominant during recent fireworks.

To repeat (and rephrase) the question: What happens next? Will credit remain quiescent? Probably not, according to Kumar and Cassot. “With the low volatility spell arguably broken and increasing talk of recession, it’s very likely that credit spreads begin to move wider to match higher volatility,” they said.

The silver lining is that corporates — blue-chips, anyway — “are starting from a very healthy position,” which to SocGen suggests “it may take some time for spreads to meaningfully widen.”