Bank of England Deputy Governor Sarah Breeden said in a US programme on Friday that the war in the Middle East has increased the chance that market stresses could occur at the same time.
She said vulnerabilities seen before past crises have not gone away but have appeared in other areas, including private markets, government bond markets, and stretched valuations.
Middle East War Raises Coinciding Market Stress Risk
Breeden referred to leverage, complexity, concentration, and opacity, and warned that if these factors materialise together, markets could face a “rocky ride”.
After her remarks, there was no clear reaction in the Pound Sterling. GBP/USD traded in a tight range around 1.3530 since the open.
A senior Bank of England official has warned that ongoing war in the Middle East increases the chances of market stresses combining. The familiar risks of leverage, complexity, and stretched valuations are re-emerging in places like private credit and government bond markets. If these issues surface at the same time, we may be in for a rocky ride.
The lack of movement in Pound Sterling, holding steady around 1.3530, suggests the market is currently complacent about these underlying risks. We see this quiet as an opportunity, especially with market volatility gauges like the VIX index hovering near historic lows of 14.5. This makes buying protection through options relatively cheap before any potential storm hits.
Hedging Strategies While Volatility Is Low
Given that stock market valuations are stretched, with the S&P 500’s forward price-to-earnings ratio sitting above 24, we should consider buying put options on major indices. This provides a direct hedge against a sudden downturn without having to sell profitable long-term holdings. It’s a strategy that paid off during the sharp, brief downturns we witnessed in the early 2020s.
We also hear the echoes from the UK gilt market turmoil back in 2022, reminding us how quickly government bond markets can unravel. With the private credit market now exceeding $2.2 trillion globally, leverage is a significant concern that has grown substantially since the calm of 2025. Traders should be looking at options on high-yield bond ETFs or credit default swaps on more vulnerable corporate debt.
The geopolitical situation in the Middle East, with renewed tensions around key shipping lanes, points directly to energy markets. A disruption could cause crude oil prices, currently stable in the mid-$80s for Brent, to spike towards the $110 level we saw during previous supply shocks. We believe long-dated call options on oil futures are a prudent way to position for such an event.
In the currency space, a true risk-off event would likely trigger a flight to safety, strengthening the US Dollar. Despite GBP/USD’s current stability, we could use this time to build positions that would benefit from a weaker pound. Buying put options on GBP/USD offers a defined-risk way to prepare for a potential sharp move below the 1.3500 level.
