I followed the steps on 3.8 and also could not replicate the issue (screenshot attached).
For line 1, I left All Circulations as Default and chose Child Nullable for Circulating Item, which resulted in ILS User -> All Circulations -> Circulating Item (left)
For line 2, I changed All Circulations to None Nullable (inner) and kept Circulating Item as Child Nullable, which resulted in ILS User -> All Circulations (inner) -> Circulating Item (left)
I followed the steps on 3.8 and also could not replicate the issue (screenshot attached).
For line 1, I left All Circulations as Default and chose Child Nullable for Circulating Item, which resulted in ILS User -> All Circulations -> Circulating Item (left)
For line 2, I changed All Circulations to None Nullable (inner) and kept Circulating Item as Child Nullable, which resulted in ILS User -> All Circulations (inner) -> Circulating Item (left)