Bank of New York Mellon (BNY) has highlighted a growing divergence in fiscal trajectories across Central and Eastern Europe (CEE), warning that this trend is amplifying carry risk for investors exposed to the region’s currencies. The analysis, which draws on recent macroeconomic data and central bank policy signals, suggests that fiscal discipline—or the lack thereof—is becoming a key differentiator for currency performance in the CEE bloc.
Fiscal Divergence in Focus
BNY’s assessment points to widening gaps between countries that are maintaining fiscal consolidation and those that are running larger deficits. For instance, the Czech Republic and Poland have generally adhered to more prudent fiscal frameworks, while Hungary and Romania have seen their budget deficits widen, partly due to pre-election spending and structural imbalances. This divergence matters for currency markets because it directly influences investor confidence, inflation expectations, and the risk premium demanded for holding local-currency debt.
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According to BNY, markets are increasingly pricing in these differences. The Czech koruna and Polish zloty have shown relative resilience compared to the Hungarian forint and Romanian leu, which have faced periodic selling pressure. The analysis underscores that fiscal credibility is becoming a more explicit factor in CEE FX valuation, particularly as the European Central Bank’s tightening cycle creates a more discerning environment for carry trades.
Carry Risk in a Shifting Rate Environment
Carry trade strategies—borrowing in low-yield currencies to invest in higher-yielding ones—have historically been popular in CEE. However, BNY notes that the risk-reward profile is shifting. While some CEE central banks have maintained relatively high interest rates to combat inflation, the fiscal backdrop is now adding a layer of uncertainty. A country with a deteriorating fiscal position may see its currency depreciate more sharply during risk-off episodes, eroding the very carry returns that attracted investors in the first place.
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The report also points to external factors, such as global risk appetite and commodity price movements, that could amplify these vulnerabilities. For investors, the key takeaway is that not all high-yielding CEE currencies offer the same risk-adjusted return. Fiscal fundamentals are now a critical filter for assessing carry trade viability.
Implications for Portfolio Strategy
For institutional investors and FX traders, BNY’s analysis suggests a need for more granular country differentiation within CEE. A blanket approach to the region may no longer be sufficient. Instead, positioning should account for each country’s fiscal trajectory, central bank independence, and external financing needs. The report also implies that hedging strategies may need to be more dynamic, particularly for exposures to currencies with weaker fiscal backstops.
On a broader level, the divergence reflects a structural challenge for the region: how to balance growth objectives with fiscal sustainability in a post-pandemic, high-inflation environment. The outcome of this balancing act will likely shape CEE FX trends for the remainder of 2025 and into 2026.
Conclusion
BNY’s warning on fiscal divergence and carry risk serves as a timely reminder that macroeconomic fundamentals remain the bedrock of currency valuation. For CEE FX markets, the era of uniform carry trade appeal is giving way to a more selective, risk-aware environment. Investors who integrate fiscal analysis into their currency strategies will be better positioned to address the diverging paths ahead.
FAQs
Q1: What is fiscal divergence in the context of CEE currencies?
Fiscal divergence refers to the widening gap in budget deficit levels and debt management practices among Central and Eastern European countries. Some nations maintain tighter fiscal discipline, while others run larger deficits, affecting investor confidence and currency stability.
Q2: Why does carry risk matter for CEE FX investors?
Carry risk arises when the returns from holding a higher-yielding currency are offset by depreciation. In CEE, deteriorating fiscal conditions can lead to sudden currency weakness, eroding the gains from interest rate differentials and making carry trades less attractive.
Q3: How can investors respond to BNY’s analysis?
Investors should adopt a more selective approach, favoring currencies from countries with stronger fiscal fundamentals, such as the Czech koruna and Polish zloty, while closely monitoring fiscal developments in higher-risk currencies like the Hungarian forint and Romanian leu. Dynamic hedging and active risk management are also recommended.
