Key Highlights

• Carry begins the year by consolidating holdings
• Precious metals price gains expected to affect terms of trade
• PLN strength may require an NBP pivot toward inflation

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iFlow Carry hits 18-month high on a holdings basis

EXHIBIT #1: RANK CORRELATION BETWEEN CURRENCY HOLDINGS AND 5Y GOVERNMENT BOND YIELD

_{Source: BNY, Macrobond}

Our take

EM FX has started the year on a positive note, and unsurprisingly, our iFlow Carry index – which tracks the alignment between FX flows and corresponding government yields – has returned to statistical significance. This indicates that the highest-yielding currencies are leading purchases, and lower-yielding currencies rank poorly in flows. Our iFlow Carry holdings index, which tracks alignment between yields and currency holdings, has also surged to its strongest level in 18 months. Because asset allocators are generally unwilling to incur large carry costs, our iFlow Carry holdings index tends to maintain a “natural position” of positive statistical significance. Apart from a brief period around “Liberation Day” and the “risk-off” round in mid-Q4 last year, high-yielding currencies have consistently been among the best held, and vice versa (Exhibit #1).

Forward Look

With no high-yielding G10 currencies – Norway is the only developed economy with rates at 4% – the surge in emerging market (EM) FX holdings suggests they are approaching extremes relative to the poor positioning of low-yielding currencies. In such cases, we believe it is necessary to remain vigilant against mean reversion, although there may still be room for these holdings to extend further. The surge in commodity prices is supporting repricing through terms of trade adjustments, while the Federal Reserve’s outlook remains an anchoring factor for EM carry. Nonetheless, 2026 stands to be a volatile year filled with event risk for high-yielding regions such as Latin America and Central and Eastern Europe (CEE). Barring further re-rating of regional economies and currencies due to structural factors, positioning extremes could prove difficult to justify. The lack of incremental dovishness within G10 central banks represents an additional risk in the near term.

Precious metals price gains help push ZAR and PEN into overheld

EXHIBIT #2: ZAR AND PEN HOLDINGS, LAST THREE YEARS

_{Source: BNY}

Our take

We expect precious metals markets to remain very volatile this year, and investors will be looking to differentiate between individual assets. While gold may retain some residual demand as a safe haven, metals such as silver and platinum are more exposed to changes in industrial demand, especially from China. Our view could change if Beijing announces a major fiscal push following the Q1 National People’s Congress.

In the short term, investment growth expectations remain subdued, and margin-constrained industries will likely curtail output due to rising input prices and national policy directives aimed at countering “involution.”

Any adjustment in these prices could then have a material knock-on impact on the terms of trade of key exporters. Gold has less impact on terms of trade, as its export production is small relative to the size of domestic economies in major producers: China, Russia, Australia, Canada and the U.S. In contrast, platinum and silver are highly relevant for the terms of trade of smaller economies – namely South Africa (75% share of global refined platinum production) and Peru (12.4% of global silver mine output). The H2 surge in these metals appears to be having a strong impact on currency performance. ZAR and PEN have shifted materially toward overheld after remaining underheld for much of 2023–2025. Equity performance is even stronger – South African equities are more than 10% above the rolling 12-month average, while Peruvian equities are up 40%.

Forward look

Commodity prices should be considered the main driver of currency performance. Both South Africa and Peru have made significant headway in managing inflation – the former lowered its inflation target last year, while Peru’s current CPI figures (Lima only) are well below peer levels. This means real rates are attractive in both countries and should anchor currency and fixed-income flows for now. How these countries manage upcoming windfalls is key. South Africa is already making significant progress on fiscal and structural reforms under the Government of National Unity, as reflected in ZAR strength and inflows into local bonds.

Peru faces a “Latin America” risk premium due to recent events in Venezuela, but it has undergone domestic political adjustments. Current polling suggests the April election may improve political alignment with the U.S. The rally in precious and industrial metals this year will generate material windfalls across emerging markets, but asset allocators will only reward economies that can avoid the “Dutch Disease” and maintain high real rates.

Upcoming NBP decision tests fiscal dominance

EXHIBIT #3: EURPLN PERFORMANCE VS. 1Y1Y FORWARD SWAP SPREAD

_Source: BNY

Our take

The National Bank of Poland (NBP) decision next Wednesday is the first major central bank decision in Europe this year. CEE was one of the best-performing regions for asset allocation in 2025. However, a bout of fiscal dominance concerns toward year end led to adjustments in asset holdings, though currencies have not yet been materially affected. PLN and HUF are well-held in iFlow and continue to trade near their 12-month highs against the euro. While the market continues to favor high-yielding EM exposure, we believe risks are now heavily skewed against the region due to the recent European Central Bank (ECB) pivot and domestic adjustments.

First, we do not believe the ECB’s shift toward vigilance against inflation is optimal due to stark differences between policy paths in CEE. Normally, we would expect CEE to show higher sensitivity relative to Eurozone policy, and regional central banks would likely shadow the ECB. This is not the case currently. Based on 1y1y forward swap spreads, PLN’s yield differential versus the EUR has dropped significantly. However, EURPLN continues to decline, which is inconsistent with typical carry trade behavior. We see this disconnect as unsustainable. The most likely reversion is a convergence where FX catches up to rates – EURPLN may recover, removing a key source of monetary restraint.

Forward look

If PLN and broader CEE’s FX performance continue to struggle, the pass-through channel will generate an additional source of upside risk to inflation. It will be difficult for the NBP to justify further easing, especially with a stronger fiscal impulse, defense-based investment from NATO and EU defense budgets, and persistent labor market supply constraints driving wage growth. At a minimum, the NBP needs to acknowledge that closer alignment with the ECB is necessary to stabilize expectations. Otherwise, financial conditions risk loosening excessively, leaving real rates exposed to rapid losses. If the ECB reverts to a more cautious approach – for which we believe the risk is high – then the NBP may regain some room to maneuver. However, this cannot serve as the base case to justify extending the easing cycle.

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