Volatility as the new regime: navigating rates, forex and geopolitical risk
Author: Pooja Tanna
The current geopolitical backdrop, particularly the escalation of war in the Middle East, has reinforced a shift that has been building beneath the surface of markets for some time. Volatility is no longer cyclical, it is structural.
At the centre of this shift more recently lies the oil market. The Strait of Hormuz has become the focal point of disruption due to the fact that roughly 20 million barrels per day, close to a fifth of global supply, typically flows through this channel. Even partial impairment to these flows introduces a meaningful supply shock and with it, a repricing of inflation expectations globally.
This transmission from geopolitics to oil, and from oil to inflation, has been swift. Markets that entered the year positioned for disinflation and a rate-cutting cycle are now being forced to reassess a world where inflation risks have re-emerged and policy paths are once again uncertain.
From duration to curve
The most immediate impact of this repricing is evident in the yield curve as can be seen in the upward shift across the curve over the past few weeks as market participants price in higher inflation and therefore higher policy interest rates [Figure 1].
Figure 1: Movement in the South African bond curve
Source: Bloomberg
In the early phase of an inflation shock, the front end of the curve adjusts rapidly as markets price out expected rate cuts and begin to consider the possibility of a more prolonged or even restrictive policy stance. This typically manifests as a flattening of the curve as can be seen in the period between the end of January and March 2026 [Figure 2].
However, as higher energy prices begin to filter through into growth dynamics, the long end starts to absorb a different set of risks, namely, the impact of tighter financial conditions on economic activity. This introduces steepening pressures over time which may result in the spread widening (increasing in value) from its current level of approximately 0.5% shown in the graph.
Figure 2: The 2yr-10yr U.S. government bond spread, indicating flattening pressures as the market prices out cuts in the short term
Source: Bloomberg
The result is a market where the shape of the curve becomes more dynamic than the level of rates themselves.
For investors, this has an important implication. The traditional approach of holding static duration exposures is increasingly insufficient. Instead, the opportunity set is shifting towards tactical curve positioning, relative value and the ability to adjust exposures as macro narratives evolve.
Oil as the anchor of uncertainty
The oil market remains the key channel through which this geopolitical uncertainty is being transmitted.
Three variables will ultimately determine the path forward:
- the duration of the conflict
- the extent to which flows through the Strait of Hormuz are disrupted
- the ability of strategic reserves and alternative supply to offset any shortfall
If the conflict proves short-lived and flows normalise, oil prices are likely to retrace, allowing the current inflation impulse to fade and policy easing to resume. A more prolonged disruption, however, would see oil prices remain elevated, embedding inflation at higher levels and delaying the easing cycle.
In a more extreme scenario, where shipping through the Strait is meaningfully impaired for an extended period, the market would need to contend with a sustained supply shock, raising the risk of a stagflationary outcome.
While strategic reserves provide an important buffer they are, by design, a temporary mechanism. They cannot replace sustained Middle Eastern supply if disruptions persist.
A shift in forex regimes
The implications extend beyond rates. The combination of geopolitical fragmentation, divergent monetary policy paths and commodity-driven shocks is driving a transition toward a more volatile environment. In such a regime, traditional hedging approaches become less effective.
Static hedging strategies, where exposures are put in place and left unchanged, fail to capture the opportunity presented by volatility. Instead, hedging must become an active process, where positions are managed dynamically as markets move. The use of optionality becomes particularly valuable in this context. Structures such as forex collars allow investors not only to protect against adverse moves, but also to position for volatility itself. As option premia decay, positions can be restructured, often leaving behind low-cost protection and, importantly, positive gamma [Figure 3].
Figure 3: Option pay-off showing the effects of positive gamma
In practical terms, this means that volatility is no longer something to be hedged away, it becomes a source of return.
Derivatives as portfolio stabilisers
This shift is equally evident in how portfolios are constructed. In a low-volatility environment, duration management could largely be achieved through allocations to cash bonds. Today, that is no longer sufficient. Derivatives, whether in the form of interest rate swaps, caps and floors, swaptions or forex options, are increasingly central to portfolio construction.
Interest rate swaps can be a highly effective tool for managing duration risk, particularly in environments where the path of policy rates is uncertain. In our case, we chose to pay fixed on 5-year swaps at levels below JIBAR, at a point where the market had already priced in a full cutting cycle. At those levels, we believed there was a natural floor in rates, with asymmetry skewed toward higher yields rather than further declines. This positioning proved effective as market expectations shifted.
As inflation risks re-emerged, driven by geopolitical developments, the market began to price out cuts and reassess the rate path, leading to a repricing higher in both bond yields and swap rates. As bond yields sold off (moved higher), swap rates moved in tandem [Figure 4], resulting in gains on the swap position that offset losses on the underlying bond holdings
Figure 4: 5 year swap moving in tandem with the R2032 government bond
The role of interest rate swaps is not to eliminate risk, but to provide flexibility. They allow investors to adjust exposures efficiently, hedge specific risks without disrupting underlying positions, and respond to market movements that are occurring with greater speed and frequency.
In our portfolios, for example, interest rate swap overlays are used to manage duration and interest rate risk while retaining upside participation. This approach enables us to navigate periods of rapid repricing without having to fundamentally alter the underlying portfolio structure.
Adapting to a world of greater uncertainty
Across rates, currencies and commodities, a consistent theme is emerging – markets are being driven less by the level of variables, whether it be yields, inflation or exchange rates, and more by the uncertainty and volatility around those variables. This has important implications for investors.
- Duration needs to be dynamic.
- Forex hedging needs to be active.
- Derivatives need to be integral to portfolio construction.
Ultimately, the ability to adapt, to re-position as conditions change and to use volatility as an opportunity rather than simply a risk, is becoming a defining characteristic of successful fixed income investing.