Using version 1.22.2. According to the release notes from VS Code 1.2, there's supposed to be an awareness of Git submodules. However, I can't seem to get this feature to work:
There is basic support in place which lets you stage, unstage or discard submodule changes in the outer repository. You can disable automatic submodule detection with the git.detectSubmodules setting.
I suspect "submodule changes" are only the top tree SHA1 (the gitlink) recorded in the parent repo index, not the files within that submodule.
The gitlink is the diff shown in the picture seen in the release notes:

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