Despite the relief rally yesterday, financial conditions have tightened significantly in the last couple of weeks. This likely explains why the Fed just made an emergency 50bps cut to the fed funds rate. The graph below highlights that the two main areas of weaker financial conditions are: 1) corporate bond spreads, 2) the VIX.
Starting with corporate bond spreads, the graph below illustrates the Fed’s concern if they let conditions remain in such ragged shape. Since financial conditions are tightly linked to corporate spreads, it seemed likely that investment grade corporate spreads would surge to around 200bps absent action.