VIX Rebounds on Fed Rate Cut Uncertainty: Moody's Analytics

US credit markets are exhibiting mixed signals, with investment-grade credit spreads narrowing slightly while high-yield spreads widen, according to the latest report from Moody's Analytics. This divergence reflects a continued belief in a soft landing for the economy, but also growing concerns about the potential for stress among lower-rated companies.

Investment-grade credit spreads, which reflect the difference between the yield on corporate bonds and risk-free Treasury yields, have narrowed for the second consecutive week. This suggests that investors remain confident in the creditworthiness of borrowers and perceive the overall economy as favorable.

"Tight credit spreads show market participants remain confident in the creditworthiness of borrowers and see the overall economy as favorable," the report notes.

However, high-yield credit spreads, which represent the compensation investors demand for taking on the risk of investing in lower-rated companies, have widened during the past week. This indicates that investors are increasingly concerned about the potential for financial distress among these businesses, potentially signaling a growing risk aversion among market participants.

Meanwhile, the VIX index, a measure of market volatility and investor sentiment, has rebounded after hitting near three-year lows. This rebound was driven primarily by a surge in Treasury bond yields, specifically the 30-year Treasury note, which neared its highest close of the month. This increase in long-term interest rates has raised concerns among investors about the pace and timing of future Federal Reserve interest rate cuts.

"Investors fear that the Federal Reserve will not cut interest rates more than once by the end of the year and not before November, as suggested by current Fed futures pricing," says Moody's Analytics.

This concern about a more hawkish stance from the Fed, coupled with the rise in long-term rates, has led to increased volatility in the stock market, as reflected in the VIX. The VIX is known to move inversely to stock prices, so its rebound signals a potential shift in investor sentiment towards a more cautious outlook for the market.

While the correlation between credit spreads and equity market volatility, as measured by the VIX, has been disrupted in recent years, the decline in the VIX last year has brought it back in line with high-yield spreads.

"Since the VIX tends to move inversely to stocks, market participants watch it closely as an indicator of investor sentiment and positioning," the report states.