The start of 2025 has been challenging for sovereign bonds in Eastern Europe, as a confluence of economic and political risks weighs heavily on the asset class. A strong dollar, rising global yields, sluggish economic growth, and renewed inflation fears are creating uncertainty for investors across the region, from Poland to the Balkans, further complicated by the impending US presidential transition.
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Economic and Political Risks Pressure Eastern European Bonds
Emerging market local-currency bonds from Hungary, Romania, Poland, and the Czech Republic are among the ten worst performers in dollar terms this year, according to Bloomberg data. Hungary leads the decline with a negative return of 2.5% through January 10th, followed by Romania at -2%. This weak performance comes as Poland, Hungary, and Slovenia launched a flurry of eurobond sales, raising a combined €6.5 billion ($6.6 billion) in early January. While this initial rush subsides, finance ministers and central bankers convened at the Invisso CEE Forum in Vienna to assess the market outlook and future issuance plans.
“Central and Eastern European bond markets are facing headwinds due to rising inflation concerns in core Europe and uncertainty surrounding potential tariffs from the incoming US President,” noted Anders Faergemann, co-head of emerging-markets global fixed income at Pinebridge Investments in London.
Adding to the economic concerns, political instability in Romania following recent elections has further roiled the fixed-income market. Upcoming elections in the Czech Republic in September add to the political uncertainty. Deutsche Bank analysts highlighted in a January 10th newsletter that “right-wing shifts across the region could strain relationships with the EU and alter foreign policy, particularly regarding Russia. Increased political fragmentation could fuel economic populism and complicate the macroeconomic outlook.”
Hungary’s Election Looms as Inflation Rises
With Hungary facing elections next year, investors are concerned that Prime Minister Viktor Orban might increase spending to bolster his chances of re-election. Economy Minister Marton Nagy recently pledged to maintain fiscal discipline after taking over the finance ministry portfolio and downplayed the risk of surging inflation, despite December figures exceeding the central bank’s target range.
Conversely, Geoff Gottlieb, the International Monetary Fund’s resident representative for Central and Eastern Europe, emphasized that inflation remains a significant challenge for the region, alongside weak external demand, rising energy and labor costs, and growing budget deficits. The phasing out of post-pandemic EU aid (RRF) next year poses another risk. “Maintaining investment while losing access to EU funds will be a tough challenge,” Gottlieb stated at the Invisso forum, though he also noted the region’s banking system remains stable.
Balancing Act for Central Banks Amidst Uncertainty
Against this backdrop of economic and geopolitical uncertainty, central bankers across the region are grappling with the decision of whether to resume interest rate cuts this year.
“Monetary policy challenges and a persistently strong US dollar make CE4 local bonds less attractive in the first quarter,” said Faergemann, highlighting Hungary and Romania as particularly vulnerable due to domestic political uncertainties.
However, there are glimmers of hope. The potential for a resolution to the conflict in Ukraine under the new US administration could spark an economic revival in Eastern Europe. Hungary’s stock market, buoyed by Prime Minister Orban’s close ties with both the incoming US president and Russia, has outperformed global peers since the US election, reaching record highs. The region’s most liquid currencies – the zloty, forint, and koruna – have also shown resilience against the strong dollar, supported by cautious central bank rhetoric.
US Trade Policy Poses Significant Risk
Despite these positive signs, significant challenges remain. “The risk of broad-based US tariffs under the new administration poses a considerable threat,” warned Rajeev De Mello, a global macro portfolio manager at Gama Asset Management SA. “For emerging market local currencies and Eastern European currencies and bonds, the combination of higher global yields and the tariff threat creates a significant headwind.”
Conclusion: Navigating a Complex Landscape
The outlook for Eastern European sovereign bonds in 2025 remains complex and uncertain. Investors must carefully navigate a landscape of economic headwinds, political risks, and potential shifts in global trade policy. While opportunities for growth exist, the region’s vulnerability to external factors and internal political dynamics demands a cautious approach. Monitoring developments in US trade policy, regional elections, and central bank actions will be crucial for investors seeking to navigate this challenging market.
