CEE FX: Regional Currencies Face Fiscal Threats – BNY

CE3 FX carry has trailed cash returns in October, according to BNY Mellon’s Geoff Yu. He notes that Central and Eastern European (CEE) assets have underperformed, with carry on the Polish Zloty, Czech Koruna and Hungarian Forint versus EUR and USD reflecting market expectations that CEE central banks cannot match the policy paths of the European Central Bank (ECB) and Fed. While CEE fixed income is stabilising, Yu cautions that France-related risk premia and Eurozone fiscal slippage could pressure CEE currencies against the Dollar, Swiss Franc and other safe havens.

CE3 FX Trails as Policy Paths Diverge

"We continue to expect CEE assets to perform strongly into year end, but October has been disappointing. FX weakness remains pronounced: An equally weighted carry basket of Central Europe 3 (CE3) currencies – CZK, HUF and PLN – against the EUR and USD is still running at just below a 1% year-to-date gain, close to 2.5pp below the cash equivalent. The EUR may have struggled over the past few weeks due to sovereign risk, while tightening financial conditions haven’t yet prompted the ECB to abandon its current policy trajectory."

"In the face of pressure from steepening yield curves, CEE central banks can hold the line on rates, leaving their respective currencies to bear the burden of adjustment. Real rates remain sufficient to anchor duration performance, and the issuance-weighted total return basket for CEE bonds continues to recover despite a more challenging environment for credit and emerging-market sovereigns with similar ratings profiles."

"Deficit risks are skewed to the upside in the near term if borrowing costs remain high and more energy support schemes are required this winter due to global supply challenges."

"Even without broad financial contagion, any associated risk premia imposed on Eurozone assets could be magnified for CEE economies, holding back performance against the USD, CHF and other perceived safe havens."

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