KBRA Financial Intelligence

3 Things in Credit: Volatility Settles, “Dangerous” Finance, and Slowdown Approaching

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about.

So, this was the week that the global stock market hit an all-time high, up a tidy 20% since its April lows, showing it’s tough to keep a good bull down. I suppose this has to do with tariff pauses, as well as AI excitement and the promise of increased productivity. Then there was this chilling comment from Vista Equity Partners at the SuperReturn private markets conference this week in Berlin: “We think that next year, 40% of the people at this conference will have an AI agent and the remaining 60% will be looking for work.” Eesh. Maybe that’s why I heard a CIO this week say, “You gotta get comfortable with being uncomfortable.”

This week, our 3 Things are:

1. Volatility settles. Are we past the storm or merely complacent?

2. “Dangerous” finance. Is The Economist’s characterization accurate or just sensationalistic?

3. Slowdown approaching. As more hard data shows slowdown, we look to this week’s Beige Book for a sentiment shift.

Alright, let’s dig a bit deeper.

Volatility settles.

I don’t have to remind you of the contrast between 2024 and 2025 in terms of things driving investor sentiment. In 2024, we had relatively clear visibility. On growth. The jobs market. Inflation. Corporate earnings. Energy prices. On policy. Yes, we did have unsettled geopolitics. But for the most part, we had certainty.

In 2025, it’s been anything but. The new administration’s policy strategy of shock and awe seemingly—and surprisingly—took on more of an ideological than a transactional bent, which reduced visibility dramatically. Recession probabilities rose to 50% or more and inflation expectations jumped. The global world order was shifting. U.S. exceptionalism was called into question.

Then we got the tariff pauses and evidence of guardrails—in the form of markets and the Treasury Secretary. All of a sudden, what looked to be ideological turned back into transactional.

As painful as it might have been, stocks and credit have done the roundtrip, with the S&P 500 returning 4.1% since the election, investment grade up 1.1%, and high yield up 3.4%. And you know what else? Volatility has returned to normal. The VIX is back under 20 and below its 20-year average. The MOVE Index, a measure of Treasury market volatility, is back below where it was on Election Day, although it remains meaningfully above its long-term average. What about credit? The VIX IG 3-Month index has fallen from a high of 81 in April back down to 34, below its long-term average, while the VIX high-yield 3-Month index has followed suit, trading below its long-term average.

Now, we’ve cautioned that markets have recovered in part on backward-looking news such as Q1 earnings, which obviously reflect momentum left over from 2024’s strong backdrop, and in part on evidence of the administration’s more transactional policy nature. The part of that equation of concern is the forward earnings look. As we laid out last week, the full-year 2025 consensus earnings estimate for the S&P 500 has fallen from a strong 15% in September to a more pedestrian 7% today. And yet multiples have bounced back to levels that support strong, not pedestrian, growth. Now, to be fair, some of that premium no doubt reflects future earnings and productivity beyond 2025—think AI. But markets still have to process tariffs that are likely to embed for good. And from that perspective, over the near term, the price of risk seems to be quite full, if not rich.

Alright, on to our second Thing—Dangerous finance.

We’re big fans of The Economist newspaper (as it refers to itself). Each week, it distills important developments around the world into very accessible and insightful interpretations.

But we take issue with its latest issue, which includes “a special report on American finance” ominously titled “New, untested and dangerous.” The predictable story line is the “transformation” of the financial system from bank-based to “a mix of asset managers, hedge funds, private equity firms and trading firms … that have emerged from the shadows to elbow aside the incumbents.” That implies that the incumbents, the banks, have been displaced, and that’s obviously not true. Alright, a bit of rhetorical excess. But then the author adds that these newcomers are “big, complex and untested. Everyone should worry about [the system’s] fragility.”

That is unnecessarily and wrongly alarmist, in our opinion. We believe the system has evolved positively since the global financial crisis, when risk was concentrated in a dozen highly levered and short-funded global banks that ceded control of their decision-making and asset marks in times of stress to adversarial regulators. By de-risking the banks, through de-levering and pushing out riskier lending into markets, regulators strengthened the system. Risk concentrated in those large banks was now diffused among a thousand institutional investors around the world. Long-term illiquid assets were now match funded with long-term locked-up money. Market discipline replaced that imposed by regulators. The result is a better shock absorber for the system in times of stress.

Ironically, the Economist piece acknowledges many of these positive developments. But it harps on the risks. The newcomers are untested. They’re opaque. Both are easy to throw out there and both are exaggerated. Disclosure in the private markets, to lenders and investors, is oftentimes better than what the banks disclose. The author worries about runs on life insurance companies where “policy holders and other lenders” to these firms “could get back nothing.” In the type of environment where that would occur, trust me, there would be no place to hide, certainly not the banks.

And further developing the contagion risk theme, the piece warns that bank loans to these “outfits” have doubled since 2020. What the author fails to provide is context. The total bank lending to private credit firms is $200 billion. That’s 1% of bank assets.

This is not to say that the system, decentralized and markets-based, is perfect. It’s not. But it is the world’s most efficient and effective in our opinion at funneling capital to its most productive use. It lies at the heart of U.S. exceptionalism. And it has positively evolved from the GFC.

Alright, on to our third Thing—Slowdown approaching.

We’ve talked recently about how sanguine markets are, basking in the warm glow of tariff pauses, as well as strong Q1 earnings (up an adjusted 10%) and so-called “core GDP” (that’s final sales to private domestic purchasers), which was up 2.9%. Economic output and earnings growth clearly reflect the momentum coming out of 2024, where the economy was performing on most if not all cylinders, and where visibility was high.

We also warned that the impact of tariffs and growing concern over policy direction is lagged, as upwards of 50% of tariffed imported goods are intermediate goods and economic scarring from things like stock market selloffs and government job cuts take a while to show up in the data. It’s beginning to get real. Housing starts, retail sales, auto sales, capex are all slowing.

This week we got the latest iteration of the Fed’s Summary of Commentary on Current Economic Conditions by Federal Reserve District, aka the Beige Book. The Beige Book is intended to characterize the change in economic conditions since the last report. Fed Chair Powell often refers to its findings. It’s published eight times a year, the last being April 23, based on surveys made on or before April 14, so in the midst of or just past the stock market’s recent bear market phase.

In the latest report, six of the Fed’s 12 districts reported “slight to moderate declines in activity,” while another three were flat. Only three districts reported growth, and it was characterized as “slight.” In the April report, five districts saw growth, three were flat, and four saw slight to modest declines. Without trying to figure out the difference between modest and moderate, overall activity has been downgraded from “little changed” in April to “declined slightly” in May. Employment is relatively steady, with only two districts reporting declines, compared to one back in April.

Peeling back the onion reveals a very different environment from a year ago:

• “All Districts reported elevated levels of economic and policy uncertainty, which have led to hesitancy and a cautious approach to business and household decisions.”

• “Consumer spending reports were mixed, with most Districts reporting slight declines or no change.”

• “There were widespread reports of contacts expecting costs and prices to rise at a faster rate going forward.”

So, nothing really unexpected here—but, more importantly, a reminder that the economy is normalizing (i.e., slowing) and running into policy uncertainty and higher costs. And that argues for building risk premia in credit.

So, there you have it, 3 Things in Credit:

1. Volatility settles. This is no time for complacency.

2. “Dangerous” finance. Not all change is risky.

3. Slowdown approaching. The Beige Book squares up with what the hard data increasingly is showing.

As always, thanks for joining. We’ll see you next week.