Fault Lines and Flashpoints: Navigating Credit Markets Through a Geopolitical Shock

Matt Freund, CFA, Christian Brobst, and Chuck Carmody, CFA

Summary Points:

• Our base case is that turmoil in the Middle East resolves or stabilizes within a couple of months, energy prices retreat by mid-year, and the Fed resumes easing in the back half of 2026.
• The defensive credit positioning we established over prior quarters proved advantageous, helping to insulate the Calamos Fixed Income funds from the widening at the lower end of the ratings spectrum.
• Fund positioning reflects our view that the yield curve will continue to steepen, and we remain highly selective in an environment of elevated near-term risks.

So much has happened in the past month that investors may have forgotten how constructive the markets were at the beginning of the year. 2026 began as a continuation of 2025’s positive credit environment. The One Big Beautiful Bill Act provided fiscal tailwinds to the economy, while the labor market held unemployment steady despite immigration-driven supply constraints. At the same time, the Federal Reserve cut rates in December, and markets were expecting two or three additional cuts during the year. Ten-year Treasury yields were drifting lower (bond prices were increasing), and credit spreads were near cycle tights. The technical backdrop remained supportive. Then on February 28, the US and Israel launched strikes on Iran, and the calculus changed materially.

Unsurprisingly, the most direct impact has been on energy markets (oil and natural gas). Iran's closure of the Strait of Hormuz, through which roughly 20% of global fossil fuels flow, removed critical supply from the market. Brent crude, which traded near $60 per barrel at the start of the quarter, surged well above $100 in March. Gasoline prices in the US rose sharply as a result. The secondary impacts on other markets quickly followed as fertilizer, helium, and carbon-dependent markets soared in price. While the US remains in a strong supply position, shortages and rationing are spreading to Europe and emerging markets. It remains to be seen how these energy-constrained economies adjust, which lower-value exports will be curtailed, and what the disruption will mean for US supply chains.

The Treasury market no longer expects the Fed to cut rates this year. Yields rose across the curve as bonds sold off. Fortunately, corporate credit entered the conflict on solid footing. Defaults (including distressed exchanges) through February remained well below long-term averages at 2.1%. High-yield leverage held under 4x, modestly above the 25-year average but not alarming. Interest coverage had stabilized. Strong inflows and robust new-issue demand had kept spreads compressed through February. High-yield spreads have widened from +266 basis points entering the quarter to slightly more than +300 as of late March, with CCC-rated credits underperforming after widening roughly +100 basis points during the quarter. Investment-grade spreads have also moved wider, reaching +90 at month’s end, leaving the market only 15 basis points wide of cycle tights.

Looking Ahead

We believe the constructive environment that existed prior to the conflict is likely to reassert itself. The fiscal tailwinds from the One Big Beautiful Bill Act remain intact. The labor market, while softening, has not broken, and US energy production insulates the US economy from shortages and minimizes the overall impact of price hikes.

Our base case is that the conflict, while severe, resolves or stabilizes within a couple of months, allowing Hormuz traffic to resume. Under this scenario, energy prices retreat by mid-year, the inflationary pulse proves transitory, and the Fed resumes easing in the back half of 2026. This would turn out to be similar to the 1990–1991 Gulf War. Credit spreads widened sharply but recovered quickly once the conflict was resolved—painful, disruptive, but ultimately finite.

The risk case involves prolonged closure of the strait, continued attacks on energy infrastructure, and oil sustained above $150 per barrel. This raises the risk of stagflation in the US and could force the Fed to stay on the sidelines or even introduce the possibility that the next move is a hike (though we continue to believe hikes are unlikely). History has shown that every major oil shock of the past five decades has been followed by an economic slowdown; the question is whether this oil shock lasts weeks or months.

Positioning Implications

Our defensive credit positioning, established over multiple prior quarters as credit spreads compressed to historically tight levels, has proven well-timed. The migration to higher credit quality across strategies, accomplished while largely preserving income characteristics, left our portfolios better insulated from the spread widening at the lower end of the ratings spectrum. As credit spreads widen (bond prices fall), we expect more attractive opportunities to deploy capital. For now, we maintain our quality bias as developments unfold.

While near-term inflation pressure argues against Fed cuts, large fiscal deficits and term premium concerns argue against a secular decline in long rates. Despite the recent shocks, Calamos Short-Term Bond Fund remains positioned longer than benchmark duration, while Calamos Total Return Bond Fund's duration remains short of benchmark, reflecting continued caution on long-end rates. For Calamos High Income Opportunities Fund, where interest rate sensitivity is a lower-order driver of returns, the fund is positioned short of benchmark duration.

Within credit, we are monitoring energy sector exposures carefully and emphasizing domestic producers over energy-intensive industrial issuers (chemicals, transportation, manufacturing) that could face rising input costs and margin pressures until the conflict is resolved. Spread widening has begun to improve relative value, but the current environment of elevated uncertainty leaves us selectively adding to credit exposure where we are being adequately compensated for the elevated risks.