The midfielder admits his side are "obliged" to improve following back-to-back defeats and has pointed to their form earlier in the campaign
The title hopefuls were undone 4-3 in the Clasico on Sunday before slumping to a 2-1 defeat against Sevilla in midweek, leaving them three points off top spot heading into Saturday's clash with Rayo Vallecano.
Madrid overturned a six-point gap to Barcelona earlier in the season after their 2-1 defeat at Camp Nou and Isco believes that run of 31 games without defeat has shown they have every chance of clinching the title in the final eight matches.
"It is a huge blow because it has completely changed the situation we were in two games ago," Isco told the club's official website.
"We are Real Madrid and are obliged to pick ourselves up. There are eight games left and we are confident in our ability to turn this situation around. We have already done that more than once.
"We came back from six points behind so why wouldn't we be able to do that now?"
In what is one of the most entertaining title races for years, Real's defeats in the past few days threaten to allow rivals Atletico to break the duopoly of Spain's two biggest clubs.
Diego Simeone's men are on track for a first league title since 1996, but Isco urged Real's fans to keep calm.
"This has been a big blow for the fans and also for us. But they should remain calm," he added.
"We are still competing in all three competitions. We are going to give it our all and fight until the very end like we have been doing up until now."