BNY’s Geoff Yu points to rising fiscal strain in Central and Eastern Europe as a driver of regional FX moves and carry trades. He says no regional central bank appears ready to push rates higher, and that fiscal policy poses more risk to inflation expectations than near-term inflation shocks.
Romania is described as facing the sharpest pressure, with the collapse of its government adding short-term fiscal uncertainty. Its twin deficits were each close to 8% of GDP in Q4 2025, alongside low real interest rates.
Poland and Hungary are also moving towards fiscal balances in high single-digit percentages of GDP. Both have recorded better current account trends over the past two years, while inbound FDI and current transfers support financing, with current transfers noted for Hungary after the election.
Yu expects common near-term inflation pressures to persist due to external factors. He also expects fiscal paths to diverge further across the region, feeding through into yield curves, currency flows, and currency holdings.
The fiscal divergence we observed across Central and Eastern Europe in late 2025 continues to be the dominant theme for our trading strategies. Central banks in the region remain hesitant to raise rates, placing the burden of adjustment on the currencies themselves. We should position for this divergence to accelerate in the coming weeks.
Romania’s fiscal and external imbalances present the clearest trading opportunity. The twin deficits, which were already approaching 8% of GDP in the fourth quarter of 2025, have shown little sign of improvement, with Q1 2026 preliminary data indicating a consolidated budget deficit of 7.8%. We see the Romanian leu (RON) as the most vulnerable currency, especially as the central bank has been using foreign reserves, which have fallen by nearly €3 billion since January, to manage the decline.
Given this outlook, we should consider buying euro-leu (EUR/RON) call options to position for further leu weakness with a defined risk. Implied volatility in the pair has already climbed from 8% to over 11% this year, reflecting growing market concern. This strategy allows us to profit from a sharp move while capping our potential loss to the premium paid.
In contrast, Poland and Hungary offer a more stable picture, supported by their stronger external accounts that we noted last year. Poland’s current account surplus held steady through the first quarter of 2026, and recent FDI data shows Hungary attracted another €1.5 billion in investments for its electric vehicle sector. This resilience makes the Polish zloty (PLN) and Hungarian forint (HUF) attractive on a relative basis.
The most direct way to trade this divergence is through relative value positions, such as going long PLN/RON or HUF/RON via forward contracts. This approach isolates the specific fiscal weakness of Romania from broader market moves driven by the euro or dollar. The spread between Romanian and Polish 10-year government bond yields has already widened by 60 basis points since the start of 2026, confirming the market is pricing in this divergence.
We should be wary of the high yields in Romania, as the carry trade is exceptionally risky here. The potential for currency depreciation far outweighs the interest rate differential, a classic trap for carry traders. The situation reminds us of the intra-Europe fiscal stress seen in 2011 and 2012, where sovereign risk concerns quickly overwhelmed yield-seeking behaviour.
