Volatility Fatigue
Markets have exhibited notable fickleness in recent weeks, oscillating between inflation concerns, geopolitical escalation, and rapidly shifting monetary policy expectations. However, the more striking feature of the current environment is not the presence of volatility itself, but rather its relative containment. Despite the US–Israel escalation against Iran and the accompanying surge in oil prices, the VIX has retraced meaningfully from its earlier highs and now sits below its long-term average. This points to a market that is increasingly distinguishing between disruptive geopolitical noise and genuine systemic risk, with investors broadly viewing the conflict as contained rather than as a catalyst for broader financial instability.
Rate expectations have also become less directional and more fragmented. Early in the escalation, markets briefly considered whether persistent energy-driven inflation could force a renewed hawkish response from central banks. That narrative has since faded. Instead, attention has shifted toward the growth-dampening effects of higher energy prices, with fuel costs increasingly seen as a drag on consumption, corporate margins, and overall activity. However, this has not translated into a unified easing cycle. Policy divergence remains pronounced: the Bank of England and European Central Bank are still expected to maintain a restrictive stance, Norges Bank has delivered a fresh hike, and in the US markets still price a marginal risk of additional Fed tightening, albeit delayed and highly data dependent. The result is a staggered global policy backdrop rather than a clean pivot toward easing.
This backdrop has supported a strong performance in high-quality fixed income, particularly US Treasuries and investment-grade credit. Though spreads initially widened following the outbreak of hostilities they have broadly since retraced, with higher-grade credit proving resilient as investors continue to favour strong balance sheets and defensive cash flows.
Importantly, this resilience is also visible in broader credit markets. The JP Morgan EMBI spread stood at 224bps ahead of the conflict and has since tightened to 216bps, now sitting below pre-escalation levels. This is a notable signal that emerging market sovereign risk has not deteriorated in aggregate, despite geopolitical noise and higher oil prices.
More broadly, sustained energy price shocks are increasingly being interpreted through the lens of demand destruction rather than persistent inflation. While such shocks can temporarily elevate headline inflation, they effectively operate as a tax on households and corporates, ultimately weighing on growth. This dynamic reinforces the structural appeal of duration and fixed income at a time when economic momentum is already showing signs of moderation.
Against this backdrop, tentative signs of progress toward a potential US–Iran understanding, however fragile, are incrementally supportive for bonds. Any credible de-escalation would likely reduce the geopolitical risk premium embedded in oil markets, ease inflation expectations, and allow investors to refocus on the broader disinflationary trend.
Importantly, the subdued behaviour of equity volatility suggests markets may already be partially pricing in such an outcome. Investors appear less focused on the risk of immediate systemic disruption and more attuned to the medium-term growth implications of tighter financial conditions and elevated energy costs. In this context, the balance of risks continues to favour high-quality duration and investment-grade credit over more cyclical or lower-quality exposures. While geopolitical uncertainty remains elevated, the combination of moderating volatility, slowing growth, and the prospect of eventual policy easing continues to provide a constructive backdrop for higher-quality fixed income assets.
If you would like to receive The Daily Update to your inbox, please email markets@epicip.com or click the link below.