Applied philosophy: Strategist from East of the Elbe - Q1 2026

The total returns on assets in Central and Eastern EU member countries (CEE11) have been strong within equities and subdued for government bonds in the last three months. Globally, inflation has increased or remained elevated in most economies alongside interest rate expectations (except crucially, for the Fed) as global economic indicators seem mixed with continuing geopolitical risks. We expect growth to reaccelerate in 2026 both within and outside the region, although we expect inflation to stay above central bank targets in the short term. In my view, this outlook should support both government bonds and equities in our CEE11 universe. 

The Christmas tree is long gone, and we are deep into winter covered in ice and snow with our thoughts turning to what 2026 may bring. Risk assets had a good start to the year perhaps looking forward to stronger economic growth and ignoring any flare-up of geopolitical risk. Is that how the rest of the year may shape up? 

Equity returns since the end of September in the CEE11 countries within our universe have remained strong for most countries, while government bond returns stayed subdued. Within equities, we highlighted Slovenia and Poland as our most preferred markets in our last edition, while we thought Bulgaria and Romania were likely to underperform (see here for the full detail). As shown in Figure 1, Poland was the second best performer, while Slovenia had the worst, albeit positive returns (only just). At the same time, Bulgaria was the fourth worst performer, while Romania was the best performer. 

Government bond returns were mostly positive, but in the low single digits for almost all CEE11 countries, except for Croatia and Latvia, as inflation stayed high. We chose Romania and Czechia as our most preferred in our last edition. Although Romania was the best performer, Czech government bonds had only the fourth highest returns. On the other hand, we highlighted Bulgaria and Croatia as our least preferred. Croatia had the second worst returns, while Bulgaria had the fourth lowest returns between 30 September and 31 December 2025. 

Government bond yields moved little since the end of September 2025 in most countries, apart from Latvia, where the 10-year yield rose by 35 basis points (bps), while it declined by 60 and 30bps in Romania and Poland respectively (as of 31 December 2025). Concerns about an economic slowdown in the US may have offset worries about inflation reaccelerating in the CEE region. The International Monetary Fund (IMF) expects fiscal deficits to rise or stay high in most countries within the CEE11 in 2026 versus 2025 (except in Romania and Slovakia), mostly driven by increased spending on defence and interest payments, in my view. 

I think the political landscape in the region is likely to be settled in the next 12 months after the Czech parliamentary election in 2025, where the populist ANO received the most votes and formed a governing coalition. The next potential flash points are the parliamentary elections in Hungary and Slovenia in April 2026. 

In our view, the global economy could reaccelerate in 2026 after going through a phase of weaker growth, especially in the US, thus some developed market central banks may be edging closer to a tightening cycle (though not the Fed). In CEE11, GDP growth in Q3 2025 picked up in most countries or remained stable, except for slower year-on-year growth in Bulgaria, Croatia, Lithuania and Romania compared to Q2 2025. I expect this cyclical upturn to continue, especially in countries exposed to higher infrastructure and defence spending in the Euro Area. 

That probably implies no significant decline in inflation in the region, and therefore interest rates may remain near current levels, in my view. I think a lot will also depend on stability in the US policy environment with mid-term elections looming in H2 2026, while geopolitical risks remain. It would not surprise me if central banks retained their gradual stance towards changing target rates, thus leaning towards holding rates close to current levels, while monitoring economic indicators. 

In CEE11 countries, I think growth will stay higher than in DM assuming decent real wage growth and no need for monetary tightening in response to higher inflation or currency weakness. In my view, fiscal policy is likely to be expansionary or neutral in most countries (apart from Romania and Slovakia, for example), although spending may be constrained somewhat by higher debt servicing costs. 

We expect divergence in monetary policy as Developed Market (DM) central banks face different challenges. Inflation has been picking up in many economies, including in the CEE11 group, while economic growth remains resilient and may reaccelerate. We expect the US Federal Reserve (Fed) and the Bank of England (BOE) to be the most doveish with two more 25bps rate cuts priced in until the end of 2026, while some developed market central banks may join the Bank of Japan (BOJ) in raising rates (rate futures indicate an increase of about 25bps), with the European Central Bank (ECB) somewhere in between with no change. As Figure 2 shows, only the Polish central bank cut rates in H2 2025 responding to declining inflation, while Bulgaria became a member of the Euro Area on 1 January 2026 and is therefore no longer shown separately. 

I think this global macroeconomic backdrop will be supportive of regional assets in general. In our latest The Big Picture, we reiterated the view that the prospects for growth may improve in the next 12 months, although there is some uncertainty around the future path of inflation, especially in the US with the potential combined impact of higher tariffs, tax cuts and Fed loosening. Accordingly, we maintained our selective overweighting of risk assets (though we upgraded high yield bonds to Neutral from Underweight and remained Underweight US equities), and we maintained our preference for Emerging Markets. 

What does this imply for markets? The main question, in my view, is how far and how quickly growth reaccelerates in 2026. Financial markets have remained positive looking ahead to a more supportive environment in 2026. I also remain positive on the prospects of both equities and government bonds within CEE11, especially if USD weakness persists (we consider them risk assets within a global asset allocation context). 

The Czech koruna, the Hungarian forint and the Polish zloty all strengthened against the euro, with only the Romanian leu weakening slightly in the last three months, which may have been driven by the difference in inflation expectations. Rate futures and Reuters consensus forecasts indicate rate cuts of about 100bps for Romania, 50bps for Poland and Hungary and no change for Czechia and the ECB, compared to 50bps of cuts for the Fed until the end of 2026 (as of 13 January 2026). Thus, it seems to me that the RON, the PLN and the HUF are likely to weaken against the euro in the next 12 months but may change less versus the US dollar. On the other hand, the CZK could strengthen against the USD, and I expect limited movements in their exchange rates versus the euro. Of course, this outlook assumes that there is no sudden deterioration of economic momentum (either within the region or globally). 

In absolute terms, the 10-year yields of Romania and Hungary at 6.9% and 6.8% respectively are the highest, which is not surprising given that they also have the highest central bank rates within the region (as of 31 December 2025 – see Figure 3). In general, I would expect CEE11 yields for Eurozone member countries to be lower than the 3.6% yield on the broader EM universe (Figure 6 – based on the JP Morgan Government Bond Index Emerging Markets Global Composite Index in USD as of 13 January 2026) due to their structurally lower inflation and interest rate expectations partly driven by currency strength. At the same time, CEE11 countries outside the Eurozone have higher yields partly reflecting higher levels of currency risk and inflation. 

With inflation increasing or remaining high in the region apart from Czechia, Poland and Slovenia, I think the critical determinant of government bond performance will be when inflation peaks. In Hungary’s case, plans for fiscal loosening before the elections in 2026 may not leave much room for strong returns, especially if interest rates remain higher than in the rest of the region. In Czechia, a lot may depend on the new government and its policies, but inflationary pressures seem to be under control, and I think Czech bonds could outperform, especially as government bond yields and spreads versus Bunds are both among the highest compared to historical averages. Perhaps with a more risk-on environment in 2026, Romanian bonds may continue to outperform. At the same time, Bulgarian and Croatian bonds seem to have the least attractive valuations with yields and spreads versus Bunds below historical averages.

I expect healthy equity returns in the region based on our assumption of global economic acceleration in the next 12 months. While there may be a few bumps in the road in the near term, valuations look favourable in most markets within the CEE11. Apart from Bulgaria, they also offer higher yields in absolute terms than the 3% of the broader EM universe (using Datastream Total Market indices as of 31 December 2025). In my view, Slovenia and Poland continue to be in the sweet spot of having a dividend yield well-above historical norms and relative to their peers in the region with Estonia and Hungary also looking attractive (see Figure 4) despite strong double-digit returns in 2025. 

On the other hand, I cannot overlook the low yields on offer on Bulgarian equities, which are also below their historical average. At the same time, although absolute yields are higher in Czechia and Romania, their yields are at a discount compared to historical norms, thus I view these markets as having the least potential for outperformance. 

Investment risks 

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.