As long-maturity government bond yields surge across much of the developed world, the broad USD index and gold prices have followed similar inverse trajectories since early 2025, with dollar weakness mirroring the precious metal’s strength. Much ink has been spilled labeling this confluence — the gold rally, a softening dollar, elevated long-term yields — the “debasement trade,” reflecting concerns over fiscal profligacy and inflation in the U.S.

Yet the negative relationship between gold prices and the dollar is nothing new, with the long-term correlation between the two at -0.42. And in fact the correlation since January 2025 has been weaker, at -0.32, because gold’s parabolic move has generated significant idiosyncratic return not explained by USD movements alone. What has strengthened is the sensitivity: since early last year, gold has moved more than 50bps in the opposite direction for every one-sigma dollar move. Looking back to 2008, there are only two prior episodes where gold was this sensitive to the greenback: the global financial crisis in 2008/9 and 2021 post-Covid. These periods were marked by aggressive balance sheet expansion and debasement fears. The current set-up lacks the aggressive monetary support of those prior instances but shares a similar backdrop of large government budget deficits.

Concerns over fiscal dominance have helped spur central bank buying, de-dollarization flows, and retail popularity, each of which has supported gold, as has Fed rate-cutting since September 2024. However, with so much money flowing into gold, its traditional status as a geopolitical safe haven is being supplanted by risk asset behavior. Indeed, gold sold off in March 2026 as the war with Iran began. Prices have yet to recover, potentially because investors poured into equities instead amid blockbuster corporate earnings announcements in April — pushing the S&P500 to record highs. Gold nevertheless remains sensitive to the dollar, so there is scope for prices to rise again if the USD remains weak.

Resurgent U.S. inflation has upended expectations for the Fed to make 1-2 further cuts in 2026, with markets now expecting a hike — putting upward pressure on the dollar. At over 3%, personal consumption expenditures inflation is well off-course from the Fed’s 2% target, and short-term inflation expectations have surged to nearly 5% in response to the energy shock. And while long-term inflation expectations have yet to become de-anchored, they have crept upwards in 2026. These also rose in 2025, undoing much of the post-pandemic monetary fight against inflation that brought long-term expectations down to 2%.

The current oil price jump is similar in magnitude to the one that occurred amid Russia’s full-scale invasion of Ukraine in early 2022, but this time the inflationary backdrop is different. Four years ago, inflationary expectations rose in lockstep with the oil price. At the time, the oil shock combined with pandemic-era supply chain delays, accelerating supply-driven price rises, along with demand-driven inflation from monetary support, fiscal stimulus, and drawdowns of pent-up savings. In 2026, long-term inflation expectations haven’t risen by nearly as much, largely because the underlying drivers are much narrower in scope: it’s a purely supply-driven shock to energy and fertilizer volumes stuck in the Persian Gulf.

The San Francisco Fed measures whether inflation is supply- or demand-driven. Much of the current spike falls into the “ambiguous” category, a methodological artifact of the SF Fed’s domestic price/quantity framework struggling to classify an external chokepoint shock. In any case, energy prices drove the large March and April inflation prints.

Amid weakness in the labor and housing markets, stagnant real wages, and a mixed consumer outlook, the Fed faces a challenging stagflationary environment where a rate hike may not be the appropriate policy response to a purely supply-driven non-core inflationary shock. This is especially true if unemployment is rising, given the Fed’s dual mandate of price stability and maximizing employment. The Fed’s rate path is currently unclear, while the structural forces behind the debasement trade are still in place. Moreover, the energy shock is more acute in Asia and Europe than in the U.S., so even if the Fed tightens policy, other central banks may also be forced to tighten – suggesting that real rate differentials are unlikely to evolve in a way that strengthens the greenback.

Despite its weakening since early 2025, the dollar remains exceptionally strong by historical standards. Meanwhile, the debasement trade’s structural drivers remain firmly in place: the 30-year Treasury yield is north of 5%, a budget deficit of 6% of GDP, supply-driven inflation, policy uncertainty, geopolitical tensions, heightened gold sensitivity to the USD. The upshot for emerging market equities is the tailwind from a weaker dollar, which cheapens FX debt servicing and increases commodity revenues, among other channels. After a blockbuster 2025 and resilience in 2026, the outlook for EM appears constructive.

The sovereign risk picture across East Asia & Pacific in 2026 is defined by the Hormuz-related oil supply shock that is feeding into current account deterioration amid government revenue mobilization pressures. Yet all but one of this region’s sample countries perform better on macro-fiscal sovereign risk indicators than most of their broad emerging and frontier market peers, making them somewhat of an EM safe haven. As with the broader EM universe, EAPAC sovereigns are benefiting from resilient global appetite for risk assets. While VIX rose in March in response to the U.S.-Israel war with Iran, volatility has remained subdued compared to 2025’s tariff reaction. Certainly, this year’s benign global investor sentiment is a mechanical tailwind that eases sovereign strains throughout EM.

However, the scale of fuel shortages across EAPAC and the reduced growth outlook globally have exacerbated sovereign risks in these countries. Mongolia is experiencing widespread gasoline and diesel shortages and has less than 30 days of inventory. The Philippines has declared a national emergency amid gasoline station closures and airlines rationing jet fuel. In Indonesia, local shortages have led the government to introduce limited subsidies for fuel purchases and asked civil servants to work from home. Vietnam’s aviation sector is experiencing a major jet fuel shortage, resulting in domestic flight cancellations. Malaysian refineries have slashed production given limited crude stocks. China is coping thanks to its enormous oil reserves and increased domestic production, although it has curbed some of its fuel exports.

Due to the severe disruptions from the Middle East conflict, the IMF has made a significant downward revision to its forecast for 2026 growth in the Philippines and, to a lesser extent, in Mongolia and Thailand. Dampened global demand is threatening sources of hard currency inflows, whether from Mongolian mineral exports, tourism in the Philippines, and Thailand, and remittance flows more broadly. In addition to the war shock, the Philippines is also experiencing high inflation, a sharp decline in public investment, and dampened investor confidence due to a flood-related corruption scandal.

While output in the region’s other countries is also at risk from the Hormuz closure, Malaysia is displaying resilient domestic strength amid tech-driven growth prospects, and Vietnam continues to benefit from structural reform, foreign direct investment, and free trade agreements. In China, state-led innovation in AI and biotechnology are offsetting a growing crisis in its property market.

Against this challenging backdrop, sound economic policies and credibility are helping to insulate much of the region from the ongoing energy supply disruption. Almost all countries in the region have significant international reserves as a share of GDP, which help protect against balance of payments crises. Only Indonesia and Mongolia likely require more of an FX buffer. Current account balances are mostly positive, with Mongolia and the Philippines exhibiting the only sizable deficits, and no country other than Mongolia exhibits are oversized external public debt burden.

Moreover, three-year real exchange rate depreciation is reducing sovereign risks in Indonesia, Vietnam, the Philippines, and China, though appreciation is a source of concern in Malaysia, Mongolia, and, to a lesser extent, Thailand. On the fiscal front, Mongolia, Malaysia, and Vietnam are all reducing their government debt burdens, and the only worryingly large increase is in China. Similarly, public debt-to-revenue ratios are comparatively low in Mongolia and Vietnam, with Indonesia and Vietnam making improvements on this metric. China, Malaysia, and Thailand all exhibit large debt-to-revenue readings but have the institutions and reserve cushions to manage the associated sovereign risks.

Mongolia stands apart as the region’s clear sovereign stress outlier. At 83.3% probability and ranked 17^th globally, it combines a very wide current account deficit (-7.9% of GDP, 91^st at-risk percentile), a large external public debt stock (41.5% of GDP, 90^th percentile), and real exchange rate appreciation into a fragile external position. China’s risk profile is shaped by a different set of dynamics: a debt-to-revenue ratio of 433 (87^th percentile) and one of the fastest rates of government debt accumulation in the sample (91^st percentile) keep its stress probability at 66.4%, despite a robust current account surplus and negligible external public debt—an unusual combination that speaks to China’s unique position in the world economy. Vietnam, while benefiting from a strong external position, carries the region’s most acute private credit vulnerability: a credit gap at the 97^th percentile flags the risk of excessive private sector leverage that could spill over into sovereign stress. Thailand and Malaysia anchor the region’s low-risk end, with Thailand’s vast international reserves (39.7% of GDP) and Malaysia’s institutional quality acting as powerful buffers against stress.

Exhibit 1

The table below presents regional countries and their data points across the ten independent variables that predict sovereign stress probability and the dependent variable of sovereign stress itself. This analysis uses data from international databases, usually in yearly format. As such, there may be discrepancies with national sources and/or higher-frequency premium data sources. Such divergences may also arise because when actual or forecast data is unavailable for the reference year, data from the previous period is pulled forward.

For some indicators such as external public debt, data may be partial (e,g, SOE debt may not be included) or wholly missing from official databases depending on government reporting. Using official databases enables fairness in cross-country comparisons, and better granularity is more easily achievable in country-specific deep-dives.

Exhibit 2

Each ring plots the absolute contribution of the ten model inputs to each country’s probability of sovereign stress. This is calculated as each coefficient-variable product’s percentage of the 10 pairings’ linearly-combined sum.

Mongolia

For Mongolia, external public debt, international reserves, and institutional quality are the largest contributors to the country’s sovereign risk profile.

• External Public Debt: At 41.5% of GDP, Mongolia’s external public debt sits at the 90^th at-risk percentile—one of the highest in the global EM sample—reflecting heavy reliance on external financing and the associated currency and refinancing risks.

• International Reserves / GDP: At 17.2% of GDP (46^th at-risk percentile), Mongolia’s international reserve coverage is the second-largest contributor to its model-estimated stress profile. While not acutely depleted, this level of reserves covers less than half its external public debt burden and is also small in comparison to the country’s yawning current account deficit (-7.9% / GDP).

Mongolia’s external vulnerabilities are the most severe in the EAPAC sample and rank near the top of the global at-risk distribution. Three-year real exchange rate appreciation of 10.0 percentage points (84^th percentile) compounds the competitiveness challenge, narrowing the path to external rebalancing. Partially offsetting these pressures, negative government debt growth (21^st percentile) and the low debt-to-revenue ratio (18^th percentile) reflect conservative fiscal policy.

Mongolia’s model-estimated probability of experiencing sovereign stress in the near-term stands at 83.3%, ranking it 17^th out of the 72 in-sample countries in 2026.

Mongolia’s sovereign risk profile is improving in 2026, with stress probability declining 4 points, the 40^th-largest improvement in the sample.

• Accelerating real exchange rate appreciation (3yr REER Δ +3.9pp, rising to +10.0pp) and a rising public debt-to-revenue ratio (Δ +8.1, from 124.3 to 132.4) are the primary risk-increasing forces in 2026 relative to last year.

• Government debt growth shifted from slight expansion to contraction (Δ −2.5pp of GDP, from +1.0pp to −1.5pp) and the current account deficit narrowed modestly (Δ +0.7pp of GDP to −7.9%); a declining stress history (Δ −0.043) adds a further mitigating signal, while the global VIX decline is a major mechanical driver of Mongolia’s improvement.

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As the consequences of the war with Iran continue to unfold, the sovereign risk picture in the Middle East and North Africa is characterized not only by the highly uneven country-level impacts of the conflict but also by resilient investor appetite for risk assets. Global risk sentiment in 2026 is less strained than in 2025. While VIX has risen by around 7 points this year, largely in response to the Gulf war, this increase is much more subdued than last year’s 21-point jump. This negative 14-point swing has mechanically improved sovereign stress probabilities across most 72 EM countries, including 10 of these 14 MENA sovereigns.

An additional sovereign risk mitigant is a softening of real exchange rate dynamics in nearly all MENA countries this year, with Tunisia as a notable exception. Other sources of improvement are idiosyncratic, such as significant declines in government debt-to-revenue ratios in Bahrain, Oman, Egypt, and Jordan. Large projected rises in current account ratios in Algeria, Oman, and — to a lesser extent — Kuwait is another.

Beneath the VIX-driven calm, the effects of the war are more sobering. The IMF has revised its real growth projections downwards for ten of the in-sample MENA countries, with countries on the Persian Gulf littoral hit hardest. Qatar and Iraq have been assigned double-digit downward revisions, while Iran, Kuwait, and Bahrain are also expected to experience large growth shocks. The impact of Israel’s offensive on Lebanon is also certain to be substantial, though the Fund provides no growth estimate. Output should be more resilient in the UAE, Saudi Arabia, and other countries in the region, while growth has been revised upwards in Algeria and Morocco.

Looking at these growth revisions in light of existing sovereign risk vulnerabilities, Iran and Iraq are already pre-disposed to stress, which is why the large hit to growth will take an especially painful toll. Kuwait is extremely resilient, almost as much as the UAE. Qatar is also in a strong position, though the nearly 15-point blow to forecasted 2026 growth will hurt. Bahrain has the weakest sovereign balance sheet in the GCC and is therefore less well-positioned than some its deeper-pocketed neighbors to withstand losing 4 points of GDP growth.

The region’s main dividing line on resilience to sovereign stress is between the high-income Gulf bloc — UAE, Kuwait, Saudi Arabia, Qatar, Bahrain, Oman — and the rest. The GCC countries are sitting on reserve buffers and current account surpluses that insulate them from stress even when other metrics suffer. There are nonetheless pockets of weakness even in this elite group. Bahrain’s relatively low reserves level and Saudi Arabia’s current account deficit are notable examples. Further chinks in GCC armor include an eye-popping government debt-to-revenue ratio in Bahrain, a large projected increase in government debt in Kuwait, and potential overheating in private sector lending in Qatar. Nevertheless, this group’s strong external balances and vast quantities of sovereign wealth assets insulate them well against strains on their sovereign debt.

The ongoing Hormuz closure notwithstanding, the real concerns in MENA’s sovereign landscape are with Egypt and Tunisia. Both these countries display weak fundamentals, ranking them 7^th and 12^th most-at-risk in the global 72-country sample, respectively. The symptoms are similar: thin reserves, heavy external debt burdens, elevated government revenue-to-debt ratios, and current account deficits in excess of 4% / GDP. Cairo and Tunis both even exhibit positive credit gaps, suggesting potentially excessive leverage in credit to the private sector. The main difference between the two is that Tunisia’s external competitiveness is suffering a dynamic of real exchange rate appreciation. In contrast, the Egyptian economy is benefiting not only from past devaluations — although the one-off shocks of large step changes are sub-optimal — but even more so from controlled, gradual depreciation in 2026.

Iraq and Algeria have the oil and gas revenues but not the institutions — governance scores near the bottom of the 72-country EM sample drag both countries into heightened stress despite their liquid cushions. And Lebanon and Iran occupy a category of their own: extreme currency collapses create a statistical paradox where the model outputs near-zero stress while on-the-ground conditions are visibly severe.

The trajectory that is most concerning for sovereign debt investors is Egypt’s. At 93.5% stress probability and worsening, it is a major economy in the region — after only Saudi Arabia, the UAE, and Iran — and one of the most precarious in the global EM sample. Whether it can engineer fiscal consolidation without choking a fragile recovery will define the regional risk picture for years. Tunisia is on a similar path with scant buffers and less diplomatic latitude. The ongoing Hormuz situation is also preventing significant fertilizer volumes from passing through the strait, now driving food prices higher in many parts of the world. One potential outcome of a food price shock in the region could be an echo of 2011’s Arab Spring that hit Tunisia and Egypt particularly hard, toppling the leaders of both countries.

Exhibit 1: MENA sovereign risk rankings

The table below presents regional countries and their data points across the ten independent variables that predict sovereign stress probability and the dependent variable of sovereign stress itself. This analysis uses data from international databases, usually in yearly format. As such, there may be discrepancies with national sources and/or higher-frequency premium data sources. Such divergences may also arise because when actual or forecast data is unavailable for the reference year, data from the previous period is pulled forward.

For some indicators such as external public debt, data may be partial (e,g, SOE debt may not be included) or wholly missing from official databases depending on government reporting. Using official databases enables fairness in cross-country comparisons, and better granularity is more easily achievable in country-specific deep-dives.

Exhibit 2: Ring charts per country

Each ring plots the absolute contribution of the ten model inputs to each country’s probability of sovereign stress. This is calculated as each coefficient-variable product’s percentage of the 10 pairings’ linearly-combined sum.

Country profiles

The percentage contribution of each sovereign risk driver across cyclical; debt and buffers; global; and governance factors is displayed in the ring charts below for each country. The contribution itself reflects only the magnitude of the effect, but not the direction. The risk percentile of each indicator reveals the directionality of the sovereign risk impact, i.e. whether that variable’s reading adds to or detracts from sovereign stress likelihood. A high at-risk percentile (e.g. 90) is the equivalent of an indicator flashing red, meaning that it is contributing to sovereign risk. A low at-risk percentile (e.g. 10) indicates that the driver is mitigating sovereign risk. At or near the 50th percentile suggests a relatively neutral effect.

Egypt

For Egypt in 2026, public debt-to-revenue, external public debt, and institutional quality are the largest contributors to the country’s sovereign risk profile.

• Debt-to-revenue: At 523, Egypt’s public debt-to-revenue ratio ranks at the 93rd at-risk percentile—a heavy fiscal burden that powerfully exacerbates sovereign stress.

• External public debt: At 27.9% of GDP, Egypt’s external PPG debt ranks at the 69th at-risk percentile, adding material external vulnerability to an already-elevated risk profile.

Egypt’s sovereign stress profile reflects a combination of fiscal fragility and governance constraints. Institutional quality at −0.58 places Egypt at the 76th at-risk percentile, reflecting governance weaknesses that are limiting policy flexibility. International reserves stand at just 9.0% of GDP (82nd at-risk percentile)—a thin liquidity buffer for an economy running a 4.2%-of-GDP current account deficit (69th percentile). The credit gap at 3.7 pp (93rd percentile) also signals elevated financial sector risk.

Egypt’s model-estimated probability of experiencing sovereign stress in the near-term stands at 93.5%, ranking it 7^nd out of the 72 in-sample countries in 2026.

Egypt’s sovereign risk profile is worsening in 2026, with stress probability rising 3.5 points, the 6^st-most worsening in the sample.

• Continued pressure from an elevated credit gap (3.7 pp, 93rd at-risk percentile) and a widening current account deficit are the primary drivers pushing stress probability higher.

• A declining real exchange rate over the past three years (REER down 8.5%, 15th at-risk percentile) is providing modest competitiveness relief, partially offsetting the broader fiscal deterioration.

Tunisia

For Tunisia in 2026, external public debt, public debt-to-revenue, and international reserves are the largest contributors to the country’s sovereign risk profile.

• External public debt: At 40.6% of GDP, Tunisia’s external PPG debt sits at the 88th at-risk percentile, reflecting a high external financing burden that exacerbates sovereign stress.

• Debt-to-revenue: At 296, Tunisia’s public debt-to-revenue ratio sits at the 64th at-risk percentile, a significant fiscal burden that is adding to debt sustainability concerns.

Tunisia’s risk profile is concentrated in its external and fiscal dimensions. International reserves of 13.5% of GDP (62nd at-risk percentile) are offering a limited buffer amid a 4.2%-of-GDP current account deficit (68th percentile). An appreciating real exchange rate (REER up 9.8% over three years, 81st at-risk percentile) is eroding export competitiveness, while elevated government debt growth (3.6 pp of GDP, 83rd percentile) and a credit gap of 1.2 pp (79th percentile) are compounding external and fiscal pressures.

Tunisia’s model-estimated probability of experiencing sovereign stress in the near-term stands at 91.0%, ranking it 12^nd out of the 72 in-sample countries in 2026.

Tunisia’s sovereign risk profile is worsening in 2026, with stress probability rising 2.3 points, the 7^st-most worsening in the sample.

• Real exchange rate appreciation (REER up 9.8% over three years, 81st at-risk percentile) is compressing export competitiveness, while continued government debt growth (3.6 pp of GDP, 83rd percentile) is adding to an already-elevated fiscal burden.

• Institutional quality, while below the median (64th at-risk percentile), is not among the weakest in the EM sample, providing some governance stability that is partially counterbalancing the external and fiscal pressures.

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In recent days, global news headlines have been rocked multiple times by bold action out of the United Arab Emirates. The one that garnered the most attention is the UAE’s announced departure from OPEC, which has also lost Qatar, Angola, and Ecuador in recent years. UAE leadership had reportedly been considering leaving the cartel for quite some time and has turned the timing to its advantage: the ongoing Hormuz supply shock has masked what might have otherwise been a decline in prices. One of the main medium-term implications is that the global oil market is likely to fracture even further. Recent prices for near-identical barrels of oil across regions have diverged by as much as $50.

The UAE’s exit from OPEC also reflect deepening tensions with Saudi Arabia on several fronts, including oil policy. With its production having collapsed from around 3.5mn barrels per day to 2mn, Abu Dhabi’s priority is to increase output. A similar logic may compel remaining OPEC members with significant spare oil production capacity, such as Iraq, to resign as well. Riyadh, on the other hand, is content to seek higher prices. In fact, Saudi oil revenues have risen despite the Hormuz closure, thanks to its ability to export oil via its pipeline to the Red Sea at Yanbu in the current high-price environment.

The American swap line dream

The UAE’s OPEC departure is also part of a tilt away from multilateralism and towards closer alignment with the U.S., and, secondarily, with Israel. Case in point, the U.S. Treasury is considering granting the UAE and a few other countries swap line access to its Exchange Stabilization Fund. Abu Dhabi is clearly seeking a dollar backstop as a confidence measure to avoid any future pressure to fire-sell its extensive USD holdings. Since Bahrain benefits from its own USD swap line with the UAE, a U.S. safety net with the UAE would help stem potential FX contagion in the region. The benefit for the U.S. would be to provide political support to a trusted ally, to strengthen the dollar’s international role, and to avoid any rise in yields and asset price declines resulting from a hypothetical fire sale.

Yet there may be limited available firepower via the ESF, because $29bn of the fund’s $42bn in available liquidity has already been committed to Argentina and Mexico. Even though these commitments remain untapped, there is little capacity to provide ESF support to other countries. The administration could mobilize U.S. Special Drawing Rights to augment the ESF, though such a complex undertaking hardly seems worth it for the UAE — given its $300bn in central bank reserves and $2tn in sovereign wealth assets. The U.S. could likely provide a greater quantity of USD swap line support to the UAE and others via the Fed’s Foreign and International Monetary Authorities repo facility. However, the administration likely prefers the ESF, which doesn’t require waiting for Federal Open Market Committee approval.

Proxy battles with Riyadh

The UAE has also demanded that its nominal ally Pakistan pay back a $3.5bn loan immediately. This move is significant because it signals the UAE’s annoyance at Pakistan’s neutral stance as mediator in the ongoing conflict with Iran and its increasing rapprochement with Saudi Arabia. Abu Dhabi’s loan collection also hits Islamabad where it hurts, given the country’s scant central bank reserves of $15bn, IMF program conditions, and fuel shortages. Riyadh has responded by providing $3bn as a deposit to shore up Pakistan’s reserves.

More to the point, the Emirates and the Kingdom are supporting rival factions in regional conflicts as they vie for regional influence. Riyadh has a degree of alignment with Pakistan, Turkey, Egypt, and Qatar, with a noteworthy rapprochement with Islamabad in recent years. Saudi Arabia supports the central government in Yemen, Sudan, and Somalia, and separatists in Libya. Cairo is aligned with Riyadh on all these fronts, as are Turkey and Qatar, except on Libya. The ongoing schism in Libya is a special case where the Saudis find themselves providing support to the eastern-based General Khalifa Haftar’s Libyan National Army alongside the Emiratis and Israelis, in opposition to the Turkish- and Qatari-supported Tripoli-based government.

In contrast, the UAE is increasingly aligned with the U.S., Israel, and India, where it has invested more heavily than in Pakistan. Abu Dhabi has tended to side with separatists in the regional conflicts, in which its chief regional ally is Israel. Joint goals are to preserve maritime routes from Iranian influence and to oppose Islamist movements in the region.

The rationale for supporting the STC southern separatists in Yemen and authorities in Somaliland and Puntland is a clear-cut play for influence over the Bab el-Mandeb strait and the Gulf of Aden. Indeed, DP World at Berbera in Somaliland is a clear example of Emirati-style Belt and Road infrastructure diplomacy. The UAE also supports Hemeti’s Rapid Support Forces in Sudan with a view to protecting Red Sea shipping, while also countering the Islamist influences within the government’s Sudanese Armed Forces.

Divisions within the GCC are far from unprecedented. As recently as 2017-2021, Saudi Arabia, the UAE, Bahrain, and Egypt had placed Qatar under a severe diplomatic and economic embargo. While it’s too early to say that the growing Saudi-Emirati split is destined for a Qatar-like rift, Iran benefits from the ongoing Hormuz closure to the extent that it weakens the UAE and Israel relative to Saudi Arabia. Although Tehran and Riyadh continue to be strategic opponents, Israel has emerged as a more direct threat to the Islamic Republic.

As such, Iran’s ruling factions may prefer to focus on undermining the UAE-Israel axis, even if doing so strengthens Saudi Arabia’s relative position. For this reason, time is on Tehran’s side. To be sure, the economic situation is dire in Iran, which has lost an estimated $50bn in oil revenues since the start of the war. Yet the regime’s willingness to inflict pain on its population in order to ensure its own survival suggests that it will tolerate the Hormuz shutdown. Every day that the Strait remains closed hurts the UAE economically much more than Saudi Arabia, and, by extent, damages Israeli and American interests in the region.

With oil spiking to $120 this week, expect Iran to feel emboldened in negotiations. While the hot war may be over for now, the Hormuz situation is far from resolved and could last months or longer.

Looking at a broad universe of emerging and frontier markets, these countries are being hit by the cross-currents of geopolitical shocks and U.S. equity market sanguinity. The International Monetary Fund has revised its growth forecasts in response to the Gulf war, and, unsurprisingly, some of the largest downward revisions are along the Persian Gulf littoral, where Gulf Cooperation Council member countries have the economic protection of strong sovereign balance sheets and cash flows.

Cratering growth is more worrying where it overlaps with sovereign fragilities, as is the case both in the Middle East and beyond. Iran, Ukraine, Iraq, Bahrain, and Equatorial Guinea all look particularly exposed, given underlying weaknesses on sovereign risk indicators and the growth hit that each is likely to experience amid the ongoing war. Meanwhile, relatively subdued volatility in global equities paints a constructive picture of EM sovereign risk that jars the senses in comparison to the scale of the Hormuz energy supply disruption.

When models surprise: the Iran anomaly

In 2024 and 2025, Iran ranked first in this Sovereign Stress Tracker — the single most stressed sovereign in this universe of market-access emerging and frontier economies. In the April 2026 update, it ranks last: 72^nd out of 72. Both rankings are correct.

The reason for this yo-yo outcome is that Iran’s real effective exchange rate had appreciated significantly in 2024-25, chiefly on the back of the country’s high inflation rate. REER appreciation is a reliable warning that the model interprets as an erosion of external competitiveness and a pressure point for sovereign stress, hence Iran’s at-risk ranking in 2024-25. In this April 2026 vintage, that signal has reversed dramatically: Iran’s three-year REER change is now a gargantuan depreciation, consistent with a currency in free-fall. Indeed, geopolitical tensions, economic sanctions, and persistent inflation caused a catastrophic collapse in the Iranian rial in January 2026.

This dramatic result vindicates the usefulness of this model, which the IMF designed to predict sovereign stress 1-2 years ahead. Hence Iran’s “top” 2024 and 2025 ranking as the country most at-risk of experiencing sovereign strains has proved prescient.

Yet the model does not know that Iran operates under sweeping international sanctions, that its oil revenues are constrained by restricted market access, or that its financial system is partially isolated from global capital flows. Nor does it capture the geopolitical realities of current Gulf war in which it is one of the main belligerents. What the model sees is a currency that has crashed so far it now registers as a tailwind that helps to decrease sovereign stress. Lebanon, for similar reasons, also clusters near the bottom of the rankings — appearing less stressed than it actually is.

This is not a flaw. It is exactly the kind of anomaly that forces a careful reader to think harder about what the numbers mean, and about which stresses are already reflected in a country’s risk profile versus which ones are still building beneath the surface. The Iran episode is a reminder that this Tracker is a baseline, not a verdict. Used as such, it is a powerful tool for systematic comparison across a large and heterogeneous universe of sovereign borrowers.

Feeling the heat: Venezuela seems most at-risk — but don’t let Iran fool you

This note is an update of the Sovereign Stress Tracker initially released in 2023. This tool is based directly on the IMF’s Debt Sustainability Framework for Market-Access Countries, and is relevant only for countries that “principally receive financing through market-based instruments and on non-concessional terms.” Through extensive testing, the IMF developed a model that measures the probability of a borrowing country experiencing sovereign debt strains in the near-term based on changes in ten governance, cyclical, debt-related, and global variables.

The heatmap describes each country’s relative performance across nine variables that contribute to sovereign stress. A tenth variable related to the Chicago Board Options Exchange Volatility Index is global in nature and thus the same for all countries, hence its exclusion from the heatmap. Yellow (purple) indicates poorer (better) performance compared to peers on a given indicator, with a worst- and best-in-class score assigned a value of “1” and “0,” respectively. Yellow (purple) readings indicate higher (lower) likelihood of sovereign stress.

Wealth matters, but policy matters more

Now covering 72 instead of 43 countries, the expanded universe in the Tracker allows for a richer income-group comparison across three tiers: 37 upper-middle income countries (UMICs), 19 lower-middle income countries (LMICs), and 16 high-income countries (HICs). As expected, sovereign stress likelihood is broadly negatively correlated with income level — but the relationship is far from deterministic.

In 2026, seven of the “top ten” countries at the highest likelihood of experiencing sovereign stress are lower middle-income: Venezuela, Bolivia, Ukraine, Sri Lanka, Egypt, Angola, and Pakistan. Iran and Lebanon would also likely be in this group had it not been for their monster depreciations. The other three countries in the April 2026 top ten are Suriname, Gabon, and Belarus — all upper middle-income countries. The overall composition of the top 10 has changed only marginally compared to 2025, with Egypt and Belarus replacing Equatorial Guinea and Croatia.

The lower middle-income sovereigns at the lowest risk of stress are all in Asia, with India and Vietnam the most resilient, followed by Indonesia and the Philippines. This is of course if one ignores the anomalous data outcomes for Iran and Lebanon, where both appear safer than they really are.

Among high-income countries, the model ranks Croatia as facing the highest probability of sovereign stress — 11^th in 2026. This is, however, a statistical quirk. Croatia is penalized strongly for having by far the largest positive credit gap in the entire sample. Such a high credit gap suggests that excessive credit to the private sector could cause excessive leverage, the economy to overheat, and, in turn, sovereign stress. Yet this outlier reading is almost certainly a data artifact, likely linked to the country’s post-communist transition after the break-up of Yugoslavia. Moreover, Croatia is also penalized for having a low reserves ratio (3.5% / GDP), which has become all but irrelevant since the country joined the euro in 2023.

The next-worst high-income performer tends to be Panama, at 15^th in 2026. Like Croatia, Panama also has low reserves (6.2% / GDP). Yet it is also unfairly penalized by the model for this since — as a fully dollarized economy — it doesn’t face currency risk on its external debt. To be fair, Panama does have a sizable external public debt burden, at over 52% / GDP, but, again, faces no currency risk on it. Romania and Bahrain are high-income countries in the middle of the pack, at the 35^th and 44^th positions in the rankings.

The remainder of high-income emerging markets occupy “low” sovereign stress rankings. The UAE is the most robust country in the sample, along with Kuwait, Saudi Arabia, Oman, Uruguay, and Qatar. Malaysia and Mauritius are two upper middle-income countries that feature at this elite end of the spectrum. It is, however, worth noting that several of these high-income countries don’t report their external public debt to the World Bank, which distorts the rankings. Economies possessing significant sovereign wealth assets could be considered to have external public debt that is either negative on a net basis, making a reading of zero somewhat less unpalatable for GCC members.

Yet the absence of external debt data for others is more problematic, including Uruguay and small island states such as Barbados, Trinidad & Tobago, and the Bahamas. Despite the rankings distortion, it was still worth including these countries in the sample. When analyzing a smaller set of countries it is easier to focus on the details of the external public debt burdens of each, but doing so is challenging when dealing with such a large sample with patchy data in official databases.

Country-level details are forthcoming

To enrich these high-level results, regional editions of the Sovereign Stress Tracker to be released in the near future will provide detailed breakdowns of contributions to sovereign stress in each country. Each upcoming report will cover a geographic region and measure how much each independent variable contributes to the probability of a country experiencing sovereign stress.

Sovereign risk has actually moderated slightly in 2026 on average

Estimates for 72 emerging and developing economies suggest that average sovereign debt strains have moderated on average in 2026, while remaining at higher levels than in 2023 and 2024. This mild improvement comes on the heels of deterioration in 2025, when stress had risen to its highest reading since 2020.

The average decrease in sovereign stress is partly explained by the high level of equity market volatility in the U.S. in 2025, as proxied by the change in VIX. As the only global variable among these drivers, that impulse pushed stress higher across the board last year. Although the VIX delta is positive so far in 2026 owing in large part to the most recent Gulf war, at +7 percentage points it is much less than the change of over 20pts in 2025. In 2024, VIX decreased, which helps explain why sovereign stress was broadly lower at any ranking level compared to 2025 or 2026.

The biggest loser: snapshot of the IMF’s growth forecast revisions

The IMF's April 2026 World Economic Outlook brought significant revisions to 2026 growth forecasts relative to the October 2025 vintage. The chart plots the 20 largest absolute forecast changes. The biggest revisions are negative, and, unsurprisingly, countries in the Gulf are hit hardest. Qatar and Iraq are looking at a double-digit declines compared to the previous baseline, underscoring the effects of infrastructure destruction and their exposure to the Hormuz closure. Iran, Kuwait, and Bahrain look like they will also experience much slower GDP growth due to the war. The UAE and Saudi Arabia look relatively insulated compared to their neighbors, likely owing to the UAE’s economic diversification, its Arabian Sea access via Fujairah, and Saudi Arabia’s East-West pipeline to the Red Sea.

Conversely, the Fund has revised Venezuela’s growth upwards by 7 percentage points. The higher oil price environment certainly explains much of the improvement, although the country’s gradual re-opening is almost certainly also set to boost growth. Yet higher oil prices don’t automatically translate into higher growth. Slowing regional growth in Central Africa, fallout from the Gulf War, and higher shipping and energy costs are set to cause a contraction in oil-exporting Equatorial Guinea — more than offsetting the tailwind from higher oil prices.

It is noteworthy that the UAE, Kuwait, and Saudi Arabia are among the most resilient sovereigns in the entire emerging markets complex. Oman — which won’t take quite as much of a growth hit — and Qatar also fare well in this tracker, as does Bahrain, albeit to a lesser degree than the others. Of the countries taking the largest downward growth revisions, Iran, Ukraine, Iraq, Bahrain, and Equatorial Guinea are the most vulnerable sovereigns.

Plug and play: the IMF’s model

The analysis is based on an IMF model that estimates sovereign debt strains 1-2 years ahead. The 10 independent variables in the model and their coefficients are listed in the table. The dependent variable in this model is sovereign stress as defined by the IMF’s MAC DSF, and includes default and certain spread and yield dynamics.

Trade-offs in expanding country coverage

The 72 countries in this sample are all high-, upper-middle, and lower-middle income countries considered to be “market-access” by the IMF and for which full data are available in 2026. Compared to the October 2025 edition, this update expands country coverage to 72 thanks to improved data collection. The previous edition included 43 middle-income countries, which has now been broadened to 56. The new edition also covers 16 high-income countries that are generally considered to be emerging markets: primarily Gulf states, Central and Eastern European EU members, and select Latin American and Caribbean economies that have crossed the World Bank income threshold.

Including a wider set of countries in the Sovereign Stress Tracker comes with trade-offs. The availability and timeliness of data is a perennial challenge, so for many countries readings from past years have been pulled forward to the present, albeit in a conservative and discerning manner. This is typically justifiable for using 2025 data for 2026, for which the only truly available data for the full year is a forecast at the time of writing in April 2026. Credit gap data is unavailable for most countries, and that missing data is mostly filled by running a HP filter over the World Bank’s credit to the private sector indicator. Nevertheless, even with this approach, such credit data is unavailable for recent years for some countries, in which cases the latest readings are presented as “0”. Moreover, independent estimates can throw strange signals, as is the case with Croatia’s highly positive credit gap — which certainly unfairly penalizes the country in these rankings.

Similarly, multiple data sources are used to ingest external public debt data, chief among which is the World Bank’s International Debt Statistics database. While these sources provide a useful baseline picture of external public debt, governments often have significant liabilities — whether on SOE balance sheets or bilateral lending hidden behind NDAs — that they do not report to the World Bank. Typically the most recent external public debt data in these sources is from two years ago (e.g. 2024 at the time of writing in 2026). Since debt stocks tend to be slow moving, it is justified to pull these external public debt-to-GDP ratios forwards. There are similar challenges associated with collecting international reserves data. However, since these tend to be faster-moving than debt, when recent data is unavailable, the last dollar reading is pulled forward and divided by the “current” year’s GDP. For all indicators, when data is unavailable in a timely manner for a specific country, a judgment call is made whether to exclude that country.

When working as intended, the model can generate bizarre signals, which is why it is crucial to interpret these sovereign stress rankings with caution. Case in point: in 2026, Iran and Lebanon appear to be least-at-risk of sovereign stress, purely because both countries have experienced extraordinarily large real effective exchange rate depreciations over the past three years. The typical interpretation of this indicator is that REER appreciations reflect a deterioration in external competitiveness, which exacerbate sovereign stress. As such, a depreciation improves competitiveness. Yet the conditions under and reasons for which depreciation has occurred in Iran and Lebanon matter greatly, as they signal economic collapse and realized sovereign stress instead of improved competitiveness.

Take this snapshot with a grain of salt

The Sovereign Stress Tracker is purely a baseline analysis of macro and debt-related indicators and fails to include crucial qualitative factors such as policy direction, commitment to reform, and credibility. The usefulness of this model is as a baseline from which to compare sovereign borrowers before proceeding with further analysis that accounts for idiosyncratic and qualitative information. It can also be used to see the direction of travel over time of countries’ sovereign debt strains.

Using TLT as a proxy for Treasuries with a tenor of 20+ years and thus as a proxy for duration writ large, here is the asset’s performance since the start of the year. I’ve also included a macro regime overlay defined on credit, the yield curve, inflation, the dollar, and VIX. Macro indicators entered risk-off stagflation in early March, as hostilities got under way in Iran: credit sold off, the yield curve flattened, and inflation expectations, the dollar, and VIX all rose. TLT declined in March, though its local peak was in late February.

Crucially, my default for defining the macro regime uses 1-month differences, with a 2-month lookback average to smooth out the data. This helps ensure enough regime stability to align with investment horizons that are longer than a few days. Otherwise, the regimes can switch from day to day or week to week, which is less useful for interpreting the the macro environment.

On the other hand, using noisier data has the benefit of giving an earlier signal. If we only look at 10-day differences and a 10-day lookback average, then risk-off stagflation ended in late March. This regime data suggests markets are in — or are heading towards — risk-on disinflation. This is the goldilocks set-up that preceded the Iran war: risk-on credit (i.e. rising high-yield credit), a flat yield curve, low VIX readings, dollar weakening, and declining inflation expectations.

TLT tends to have positive returns during risk-off stagflation regimes that are followed by risk-on disinflation. Of the eight such examples since 2007, TLT returns have been positive in five of them, with negative returns in late 2016, 2022, and in the 2026 vintage so far.

If risk-on disinflation does materialize as the next macro regime, then it’s worth knowing that TLT’s average annualized returns in this environment has been around +3% since 2007. Yet those results are highly variable.

Looking at TLT performance in risk-on disinflation regimes in recent years shows negative returns amid tight Fed policy in 2022 and 2023. TLT also declined in Q4 2020 as investors dumped safe havens like Treasuries in favor of risk assets. Positive returns coincided with easing Fed policy in 2024-25 and 2019-20, and in 2021 amid safe haven demand and easing fears over imminent Fed rate hikes.

As always, the most important question for virtually all asset classes and long duration ones in particular — whether Treasuries or growth equities such as tech — is the U.S. inflation trajectory and the Fed’s response to it.

Before diving into the inflation debate, there is some asymmetric upside in being long duration, i.e. bullish. Think through the following three scenarios regarding Iran:

• Durable end to the Iran war, Hormuz re-opens and stays open: At the time of writing, Iran has already re-opened the strait, though the U.S. blockade remains in effect. An Israel-Lebanon ceasefire, which Hezbollah will likely adhere to, is now in effect. Thus in this scenario the energy shock fades, inflation pass-through to the U.S. is minimal. The Fed can resume its rate-cutting, which will likely boost duration assets.

• Hostilities resume, and/or an ongoing Hormuz blockade aggravates the oil supply shock: fuel prices remain elevated, shortages worsen, and the stagflationary impulse tips over into demand destruction, containing inflation and requiring Fed easing. Another upside scenario for long duration positions.

• Middle path: This scenario seems the least likely, where the energy shock continues long enough to push U.S. inflation upwards meaningfully but ends quickly enough to avoid economic scarring. In this case the Fed leans towards tighter policy, ceteris paribus.

There are obviously many variables in the U.S. inflation picture other than the Iran war-related oil shock, with many conflicting signals in the U.S. job market and inflation indicators clouding the outlook. I’ll dig into those in my next piece.

Since 2007, annualized returns for TLT average out to nearly 40% under this regime, but that headline number masks highly uneven outcomes. Since 2020, there’s an even split between positive and negative TLT returns during risk-off stagflation:

In the thirteen risk-off stagflation occurrences that I’ve counted in 2007, TLT annualized returns were negative in five of them, including the current, ongoing one:

• July 2013, -30%: Bernanke’s May 2013 remarks hinting at a reduction in Fed bond purchases provoked a “Taper Tantrum”, causing bond yields to rise over that summer.

• February 2015, -57%: On the back of a strong payrolls report and subsiding fears over deflation, investors began to expect Fed rate hikes would come sooner than previously anticipated and rotated out of risk-off bonds and into attractively-priced equities.

• September-October 2015, -5%: Growing fears of an economic slowdown in China had triggered an S&P500 correction in August 2015, followed by stabilization in September and a rally in October. August’s safe-haven inflows into TLT gradually gave way to expectations in September and October that a Fed rate hike would be brought forward.

• February-March 2022, -49%: Russia’s full-scale invasion of Ukraine coincided with the end of pandemic-era monetary policy, as the Fed’s delayed reaction to Covid-related inflation occurred at the same time as the Ukraine-related surge in energy prices. Inflation and rate hike expectations surged, and the Fed began its hiking cycle that March. Bonds suffered historic losses.

• March 2026 - today, -25%: The Iran war has pushed the entire yield curve up in a bear flattener, thus hitting TLT, which is down almost 3% since early March. The surge in energy prices has dampened market expectations that the Fed would continue its rate-cutting cycle in 2026.

Looking at risk-off stagflation episodes of positive return for TLT, July-September 2011, March 2020, and November 2023 stand out as the best performances. In annualized terms again, for comparative purposes:

• July-September 2011, +152%: extreme equity market volatility and flight-to-safety flows drove bonds and TLT higher. The U.S. debt ceiling crisis, the first ever downgrade of the U.S. sovereign debt rating, and the unfolding European sovereign debt crisis paved the way towards a risk-off shock regime in October 2011.

• March 2020, +165%: The Covid-19 financial market crash saw investors dump equities and bonds in unison, prompting the Fed to intervene rapidly and aggressively through quantitative easing. The massive liquidity injections and eased financial conditions helped prices on Treasuries recover strongly after the initial drop.

• November 2023, +258%: After months of declines for stocks and bonds alike, bonds surged in November 2023 on the back of a cooler-than-anticipated inflation print. Market observers felt that the Fed had reached the peak of its hiking cycle by this point.

For today’s Iran war set-up, the biggest questions surrounding duration are the extent to which higher energy prices will feed into higher inflation and slower growth, and the Fed’s ensuing response. Even if traffic through Hormuz were to revert to pre-war levels (it’s not), this new reality with continue to push up inflation and pull down growth.

Fed tightening territory still seems a long way off. The U.S. labor market displays significant weakness, as proxied by ISM employment, the hire rate, and weather-adjusted non-farm payrolls. The strong headline NFP jobs print for March is negative if considering unseasonably warm weather in many parts of the U.S. In the past, the Fed has cut rates in response to oil shocks — with 2022 being a notable exception.

Moreover, global trade operations have become more expensive since the beginning of the Hormuz crisis, raising insurance premiums, stretching supply chains, incentivizing inventory build-up, and tying up liquidity. The result is tightened balance sheets and likely a drag on growth. Many analysts are worrying about the risks of an economic slowdown — either in the U.S., globally, or both — as the energy shock persists into 2026. They argue that too much tightening has been priced into the long end of the curve and that long-end yields have room to fall.

There are nevertheless some pressures towards tightening. Some analysts point to indications of U.S. labor market strength, including a cyclical upswing and indicators measuring permanent layoffs and the “good unemployment” of labor market re-entrants. Inflation expectations are also rising.

If the current levels of gasoline prices persist in the U.S., a back-of-the-envelope calculation suggests a 0.6 percentage point rise through this channel alone in personal consumption expenditures, the Fed’s preferred inflation measure: gasoline accounts for ~1.7% of PCE, so the ~37% rise suggests an inflationary impulse of around +0.6 points — depending on how long and how high prices at the pump last. This crude calculation of course ignores plenty of other first-, second-, and third-order effects that are driving on and weighing on inflation.

It’s hard to make a call either way, but after a decline of nearly 3% since early March, TLT looks relatively affordable after this tightening episode. It would likely take a large positive inflation surprise to pull TLT down much further and only moderate economic weakness and/or a resumption in the Fed’s cutting cycle to push it higher.

Given the scale of the supply disruption, the percentage rise in oil and fuel prices so far has been muted relative to past episodes. The world is less vulnerable to oil supply shocks thanks to declining energy intensity of economic activity in recent decades. Moreover, the U.S. itself is also less exposed thanks to the rise in shale production and stronger energy independence. This decreased vulnerability helps explain why the movement in U.S.-centric global macro factors — credit, USD, the yield curve, 5-year inflation expectations, VIX — in response to the Iran war has been relatively subdued.

Given Asia’s heavy reliance on Gulf oil, prices on Asian-bound crude oil shipments have risen more than elsewhere. The spread Brent-West Texas Intermediate spread widened in March, as buyers from Europe and elsewhere rushed to replace lost Gulf oil with any suitable nearby replacements, including Brent.

However, the Brent-WTI spread inverted on April 2 for the first time in four years after Trump failed to clarify a path forward towards ending the war. His comments prompted a surge in demand for immediately deliverable U.S. barrels, resulting in what is effectively a security premium. In fact both Brent and WTI are in backwardation — referring to spot prices being above futures prices, reflecting high immediate demand and shortages.

Energy Crisis Responses

Several countries have responded to the crisis with a coordinated release of 400mn barrels in strategic oil reserves, with perhaps more on the way. Prior to release, global reserves stood at: China’s 1.3bn barrels (110 days), the EU’s 570mn (90 days), the U.S.’s 415mn (120 days), and Japan’s 470mn (224 days). Together these comprise some 75% of the worldwide total.

The U.S. share of the release amounts to 172mn barrels over 120 days, at least 45mn of which has already been released. To further alleviate oil price pressures, the administration has taken the controversial step to temporarily lift sanctions on Iranian and Russian crude and refined products, estimated at 130mn and 105mn barrels. The government is also now allowing shipping between U.S. ports by foreign-owned vessels. Other options could be on the table, including waiving gasoline’s ethanol content limits and an export ban — which would hurt European buyers. The government could also suspend the federal gas tax if it can secure congressional approval.

Prices of refined products such as gasoline, diesel, and jet fuel matter more to consumers and voters than the price of crude oil. These fuels are also better proxies for the Gulf supply shock than crude, as the market for these is more truly global. With some ships carrying these fuel products currently stuck in the Gulf, there is a direct worldwide effect.

There is significantly more pain outside the U.S., ranging from fuel shortages in Asia to significant pressures on consumers and governments in Europe. While American gasoline prices have risen from under $3/gallon in late February to above $4 currently, this remains below the $5 level attained in 2022. Gasoline and diesel prices have risen faster in several Asian countries and Australia than in the U.S.

Although the fuel price jump has been slower in parts of Europe than in the U.S., consumers are under more pressure given the significantly more expensive price levels at the pump. Italy has introduced a $577mn tax cut on fuel to mitigate costs to buyers until early May. Similarly, the French government is introducing aid measures targeted towards some of the most-exposed professions. The European Commission has asked for populations to conserve energy, including by driving less.

Yet it is in Asia where the energy crisis is most acute, where the four largest consumers are China, India, Japan, and South Korea. The latter two are most exposed with 93% and 72% of their oil/gas imports coming from the Gulf, while India and South Korea have only 74 and 73 days’ cover of Gulf oil. Many countries in the region have much shorter runways, with high energy import reliance exacerbated in many cases by limited fiscal room. Unfortunately, replacing Gulf oil with U.S., Brazilian, and West African crude wouldn’t be feasible since Asian refineries are specialized in processing Middle Eastern grades.

Asian governments are pushing a wide range of policies, including work-from-home, limiting school opening times, introducing cooling temperature limits, promoting efficient transport, and restricting fuel sales. The Philippines, Myanmar, Thailand, and Vietnam have already begun rolling out a variety of fuel demand-management measures. Bangladesh is limiting diesel and gasoline sales, while India is redirecting fuel from industry to households. The fuel and rationing policies in Asia are comparable to measures taken during the 1970s’ oil crisis.

Macro Regime Positioning

The Iran war has pushed global macro factors into a risk-off stagflation regime, which refers to a combination of high volatility, a flat curve, risk-off credit, rising inflation, and a strengthening USD. Looking across broad themes and asset classes, this is a challenging environment, as many assets tend to experience negative returns. To help inform portfolio positioning, it is essential to take a view on how long the current conditions will persist and which regime might come next.

Since 2020, there have been four risk-off stagflation episodes, each of which has lasted only about one month. In fact, looking back to 2007, only two occurrences lasted significantly more than that, at two and three months respectively. More benign, risk-on conditions tend to follow, but sometimes risk-off stagflation deteriorates into a risk-off shock: high vol, a steep curve, risk-off credit, declining inflation, and a strengthening USD.

Looking at past regime transitions, in a risk-off stagflation regime with a low oil price environment, there is a 1/3 probability of transitioning to risk-on disinflation and a 2/3 chance of risk-on reflation. When the oil price jumps amid risk-off stagflation conditions, the probability of a risk-off shock jumps from 0 to 22%. Risk-on disinflation rises to 56% and risk-on reflation declines to 22%.

There are limits to how much we should look into this. First, there aren’t enough regime transitions in my data going back to 2007 to infer statistically-significant trends. Second, there is necessarily an element of subjectivity when choosing how to define a regime, i.e. which factors to select, how much to smooth the data considering the trade-off between stability and sensitivity. Nevertheless, looking at past patterns within this type of rigorous frameworks helps to discipline thinking and decision-making.

More importantly, the Iran war’s impact on energy and growth is unevenly distributed across geographies, which provides useful signals for positioning. It’s clear that demand destruction is already occurring on a large scale in parts of Asia and that Europe and the U.S. will also be affected. Sell-side forecasts are unsurprising in predicting lower growth and higher inflation, both globally and in the U.S. The Fed has already had to put planned rate cuts on hold in reaction to higher energy prices, with a strong March jobs report also bolstering the case against loosening. However, if the energy crisis begins to hit growth hard in certain countries, those central banks may ease policy — including in the U.S.

In the next piece, I’ll develop scenarios for the Iran war and map those onto regime transitions. I’ll also break down how some different types of asset classes tend to perform in scenario-relevant regimes.

Ever since renewed hostilities against Iran commenced on February 28, the stagflationary effect of closing the Hormuz Strait has become increasingly clear. The problem for investors is that predicting the geopolitical variables of interest is nigh-on impossible. How long will Iran keep the strait closed? Beats me. Which countries’ ships will Iran define as friendly and let through? Unclear. How much more damage will the warring parties inflict on the region’s energy infrastructure? Who knows.

Fortunately, it is possible to at least define and measure the current macro regime in which we find ourselves and to derive clues about what comes next. One way to define a macro regime is to use a machine learning technique called k-means clustering to sort time periods based on macro factor behavior. Using volatility, credit, the yield curve, USD, and inflation, I’ve defined four U.S.-centric macro regimes:

• Risk-On Reflation: low vol, steep curve, risk-on credit, rising inflation, weakening USD

• Risk-On Disinflation: low vol, flat curve, risk-on credit, declining inflation, weakening USD

• Risk-Off Stagflation: high vol, flat curve, risk-off credit, rising inflation, strengthening USD

• Risk-Off Shock: high vol, steep curve, risk-off credit, rising inflation, strengthening USD

There are many ways to define macro regimes, and indeed I’ve also implemented separate frameworks that I’ll discuss later. Focusing on the k-means regimes for now, as of March 2026 we have transitioned from what I call risk-on disinflation to risk-off stagflation. Financial assets perform differently across different regimes, and that past behavior can help make an investment case.

Yet the devil is in the details. The start of this latest bout of risk-off stagflation varies by how I wrangle the data for the clustering calculations. Using daily movements with little-to-no smoothing, regimes become highly unstable, sometimes changing daily based on the day’s macro factor moves. Smoothing over multiple weeks results in stable regimes suitable for most investment horizons, but are slower to react to new data. So although timing the market is as much of a fool’s errand as trying to predict geopolitics, it is nevertheless a crucial variable when measuring regime-dependent expected returns. But let’s get back to recent events.

March Madness

The pain has been widespread. The S&P500 is down about 7% since the beginning of the month. The traditional 60-40 equity bond portfolio has dropped by nearly as much, with several broad corporate and government bond indices declining by 3%. Yields on 10-year U.S. Treasuries have surged by over 50 basis points, from 3.97% on February 27 to 4.48% on March 27.

Sophisticated investors have gotten slammed, with marquee macro names Caxton, Brevan Howard, and Taula shedding billions collectively. Call this March-to-forget what you will: March Madness. The Ides of March. Or echoes of March 2003. The set-up has indeed been difficult for investors, with many asset classes getting hit.

Yet there have been a few bright spots, including of course oil but also the dollar and agricultural commodities, to name a few. This points to the fact that it is possible to hedge even these challenging conditions. Imagine for a moment that in late February you were holding a typical 60-40 portfolio of the S&P and investment-grade corporate bonds. This particular book happens to have positive macro factor exposures to credit (by definition), metals, and the dollar, and negative ones to volatility, oil, and Treasuries.

With the Iran war erupting, your holdings would then have several macro factor exposures working against them, including credit, oil, volatility, and metals. And while managing your factor exposures can’t fully insulate you from the unpredictable, they can help you with your scenario planning.

So, what’s the upshot? Well, it depends how long this Iran business is going to last. And even were it to end tomorrow, the second- and third-order effects have only just begun to play out, beginning with the scrapping of oil sanctions on Iran and Russia. I’ll dig into those topics in future posts.

For now, having entered risk-off stagflation, several ideas come to mind that I may explore further. Duration can perform well thanks to post-drop rebounds, as can certain currencies or precious metals. Oil doesn’t work well in this set-up, but I’d still want some affordable long exposure. Besides, it’s unclear how long this regime will endure: even with my smoothed data and stable definitions, in recent years risk-off stagflation has been short-lived. With that in mind, I’ll be assessing how quickly a new macro backdrop might emerge, so stay tuned.

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