Best Emerging Currencies Lose Steam as Rate-Hike Bets Wane By

(Bloomberg) — Some of this year’s best-performing emerging-market currencies are falling out of favor as traders trim back bets on further interest-rate hikes.

The Brazilian and the Russian , which outpaced most of their peers in the first half amid policy tightening, have now gone into reverse. The real has slumped about 4.5% since the end of June, more than any other major currency tracked by Bloomberg.  

The tightening cycle was in full force in emerging markets long before the Federal Reserve started laying out a timeline for scaling back its bond-buying program, which Chair Jerome Powell said on Friday could begin as soon as this year. The early hikes in Russia and Brazil have helped stem flows from emerging markets, though policy makers are still balancing the need to battle inflation with the desire to support economies battered by Covid-19. 

Poland and Colombia may be next to lift rates. That offers some upside potential for lagging currencies such as the Polish , protecting their relative yield advantage against accelerating prices and the prospect of rising U.S. rates.

“Early hikers, where the speed of tightening has been in line with or in some cases faster than historical hiking cycles, are likely to slow the pace of hikes or pause in the months ahead,” Goldman Sachs Group Inc (NYSE:). strategists led by London-based Kamakshya Trivedi wrote in a note this month. “The second half of the emerging-market hiking cycle is likely to be even broader, with more central banks commencing some form of normalization.”

Evolving Environment

Brazil’s central bank has already increased its key rate by 325 basis points this year, more than most peers, and forward-market bets are pricing in slowing rate hikes after September’s meeting. In Russia, traders predict the central bank will increase its benchmark by about 50 basis points over the next three months, down from more than 130 points in early July. 

This evolving rate environment presents a crucial opportunity for traders to take advantage of variations in the next phase of the emerging-market tightening cycle, according to Goldman Sachs.

South Korea became the first major Asian country to raise interest rates this year Thursday, with more hikes in the pipeline as the focus pivoted from propping up the economy to curbing a debt-driven asset bubble. 

The won rose before relinquishing its gains after Korea’s central bank governor remained ambiguous on the timing of the next move. The currency should strengthen on a hawkish “Bank of Korea, economic resilience and a technically oversold won,” said Mitul Kotecha, chief emerging markets Asia & Europe strategist at TD Securities in Singapore.

“Markets will likely continue to chase yield, meaning those countries, with relatively aggressive monetary stances and higher real yields will benefit most,” he said.

Balancing Act 

It’s a delicate…