If the Fed is forced to hike, EM should stay cautious in the short term but can still be bought on dips over the medium to long term

Overview

This is a Bank of America Global Emerging Markets weekly report focused on what EM assets should do if the Fed is forced to hike again. The report notes that high oil prices, upside global inflation surprises, and Fed policy uncertainty could end the earlier low-rate-volatility regime and lift EM volatility. Even so, the authors still believe that structural USD weakness, high EM real rates, and relative value in selected regions keep EM in a buy-the-dip setup over the medium to long term.

Core views

The report's core conclusions are: first, the Fed hike risk is not the only issue; the key question is whether it is accompanied by a stronger DXY. Higher US rates and a stronger USD are the most unfavorable combination for EM. Second, if global growth expands in sync and the USD weakens, EM can still perform well even when US rates rise; however, high oil prices are more likely to hit Asia and Europe asymmetrically, which would be relatively favorable for the US. Third, current carry and volatility risk premia are low, and upside global inflation surprises, oil prices, and changes in Fed leadership in May and June could make the market environment less friendly. Fourth, regional allocation should shift away from broad high-beta exposure toward trades with clear value, carry, or hedging characteristics.

Analysis framework

The report uses a macro scenario and cross-asset relative value framework: Fed policy, the US yield curve, DXY, oil prices, and global growth divergence serve as the top-level variables, which are then mapped into EM FX, local currency bonds, inflation-linked bonds, sovereign external debt, and regional relative value trades. The regional chapters further combine inflation, fiscal conditions, politics, current account balances, energy exposure, exports, and tourism to derive specific trade preferences across Asia, EEMEA, LatAm, and sovereign debt.

Methodology notes

• Macro scenario analysisUS rates and DXY dual-variable scenario

  EM performance depends on whether higher US rates are accompanied by a stronger USD.

  The report argues that higher US rates alone do not necessarily suppress EM. If they coincide with synchronized global expansion and a weaker USD, EM can do well. But if high oil prices slow Asia and Europe while the US proves more resilient, then higher US rates plus a stronger DXY becomes the most dangerous combination.

• Cross-asset strategyRate volatility and yield-curve regime

  Fed easing expectations had previously suppressed rate volatility, and a steeper curve is usually favorable for EM.

  The report uses BofA MOVE and other rate-volatility indicators to discuss EM risk appetite; if the Fed turns hawkish and the curve bear-flattens, experience over the past decade suggests this is typically unfavorable for EM.

• Regional relative valueEM FX, rates, and EXD tradebook

  When macro uncertainty rises, prioritize trades with valuation, carry, energy, or hedging advantages.

  The report lists long and short trades across Asia, EEMEA, and LatAm, such as long SGD NEER, CNH, MYR, NGN, Hungarian long-end bonds, Argentine BONCER 2028, and PEN relative to a basket, while using long USD/ZAR as a hedge against oil prices and risk sentiment.

• Country fundamental researchTracking inflation, fiscal policy, and political risk

  Country chapters evaluate assets using inflation paths, fiscal rules, issuance plans, political continuity, and growth momentum.

  The South Africa chapter raises inflation and hike expectations, the Hungary chapter emphasizes fiscal consolidation and a lower inflation target's impact on bonds and swaps, and the Costa Rica chapter focuses on the new government, fiscal rules, tax revenue declines, and tourism growth.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Emerging Markets

  A macro risk asset highly correlated with the USD, US rates, oil prices, and the global growth cycle

  Strengths

  Structural USD weakness, high carry, and relatively high EM real rates provide medium- to long-term support.

  Weaknesses

  Risk premia are low, and EM can come under pressure if higher US rates are accompanied by a stronger DXY.

  Comparison

  EM can outperform when global growth expands in sync and the USD weakens; it tends to underperform when the US shows relative resilience and Asia and Europe are hit by oil shocks.

  Risks

  Fed hikes, further oil price gains, a stronger DXY, and a rebound in rate volatility.

• Asian FX

  Affected by energy imports, current accounts, RMB dynamics, and regional growth divergence

  Strengths

  The report favors SGD NEER, CNH, and MYR for reasons including policy tightening, valuation resilience, China proxy exposure, and energy exports.

  Weaknesses

  INR, PHP, and THB are seen as potential laggards because of energy prices and current account pressure.

  Comparison

  INR and THB are viewed negatively relative to KRW; MYR is better supported than other Asian energy import currencies.

  Risks

  Further increases in energy prices, insufficient tourism income, and an Asia growth shock.

• China macro and RMB

  Inflation, exporter FX conversion, dividend-related FX demand, and PBoC fixing all affect USDCNY

  Strengths

  Strong exports, trade surplus, and exporter FX conversion provide dollar supply and support the RMB.

  Weaknesses

  Dividend payments from June to August will create seasonal FX demand that may slow RMB appreciation.

  Comparison

  Dividend-related FX demand is about US$20bn per month, below the roughly US$60bn per month of trade-related net dollar supply seen in February and March.

  Risks

  Weak domestic demand, imported inflation from higher energy prices, and policy management of rapid appreciation.

• South African local rates and ZAR

  Affected by inflation expectations, SARB policy, energy prices, fiscal conditions, and political risk

  Strengths

  Long USD/ZAR is viewed as an effective hedge against high oil prices and weak EM risk sentiment.

  Weaknesses

  Rising inflation, wage pressure, fiscal revenue risk, and increasing political risk.

  Comparison

  Rather than taking direct South Africa exposure, the report emphasizes using long USD/ZAR as a high-beta risk hedge.

  Risks

  SARB hikes, food inflation, energy shocks, and weaker-than-expected fiscal revenue.

• Hungarian local bonds and swaps

  Affected by fiscal consolidation, the inflation target, euro convergence expectations, and the global EM backdrop

  Strengths

  The report is structurally bullish on Hungarian local bonds and swaps, and thinks the curve still has room to move closer to the Czech and Polish structure.

  Weaknesses

  The global EM environment is unfavorable in the short term, and HGB positioning is crowded.

  Comparison

  The report thinks the POLGB/HGB spread signal may be misleading, and that the Hungarian curve should outperform Poland's going forward.

  Risks

  A decline in global risk appetite, energy shocks, crowded positioning, and limited further room for HUF appreciation.

• LatAm local markets

  Affected by US rates, commodity conditions, central bank policy, elections, and relative value

  Strengths

  The long-term view remains constructive, with a preference for BRL, PEN relative to a CLP/MXN basket, Mexico inflation breakevens, and Argentine real yields.

  Weaknesses

  The risk of higher US rates is still not fully priced in the short term, so tactical caution is warranted.

  Comparison

  The report favors Argentina and Ecuador while maintaining a short Colombia vs Brazil view.

  Risks

  Higher US rates, regional election risk, commodity price reversals, and localized policy uncertainty.

• Dominican Republic sovereign bonds

  A regional sovereign external debt relative-value trade

  Strengths

  Valuation has improved, tourism could prove resilient, and it offers the strongest relative value in the region.

  Weaknesses

  It is still exposed to global sovereign-spread and USD-rate conditions.

  Comparison

  The recommendation is to go long DOMREP 60s and short a basket of GUATEM 55s and COSTAR 54s.

  Risks

  Wider global spreads, weaker-than-expected tourism, and continued US rate increases.

Key data

• Report date2026-05-15The title page shows 15 May 2026; the file date is 20260517.
• China June-August dividend payment estimateabout US$61bnSlightly above last year, which may only marginally slow the decline in USDCNY, but is unlikely to reverse RMB appreciation.
• China April CPI1.2% YoYUp from 1.0% in March, driven by both energy and core inflation.
• China April PPI2.8% YoY, 1.7% MoMPPI was positive for a second consecutive month, and the monthly increase was the largest since 2021.
• China April trade surplusUS$85bnDollar supply from exporter FX conversion continues to support the RMB.
• South Africa April CPI forecast3.8%Up from a prior forecast of 3.7%, driven by energy and services prices.
• South Africa CPI peak forecast4.7% in Feb 2027It is then expected to ease to 4.1% and 3.7% in April and May 2027.
• South Africa policy rate path25bp hikes in May and July, peak at 7.25%The report thinks the first rate cut may not come until May 2027.
• Costa Rica 2026 GDP growth forecast3.7%Although momentum is slowing versus before, it may still outperform regional peers, supported by exports and tourism.
• Costa Rica 2026 financing coverage76% of domestic issuance plan, 71% of total issuance planThe government front-loaded financing early in the year.
• Dominican Republic rating actionUpgraded to OverweightBased on improved valuation and the strongest relative value in the region, the report recommends going long DOMREP 60s and shorting a basket of GUATEM 55s and COSTAR 54s.

Impact & implications

For portfolios, the report recommends reducing dependence on low risk-premium and strong risk-appetite environments, and avoiding excessive exposure to high-beta EM assets during a potential Fed hawkish shift, high oil prices, and a stronger USD. A better approach is to remain structurally bullish on EM while waiting for volatility-driven entry points, and to prioritize assets with carry, attractive valuation, energy tailwinds, or defensive characteristics. At the country and regional level, China's inflation has rebounded but domestic demand remains weak, so RMB appreciation may continue; South Africa faces inflation and rate-hike pressure; Hungarian bonds and swaps are more likely than FX to benefit from the policy theme; Costa Rica has policy continuity and growth resilience but a pressured tax base; and LatAm local markets remain attractive over the long term, though trades need to be selective in the short term.

Risks

• The Fed is forced to hike or markets further increase the probability of a hike.
• High oil prices persist and trigger upside global inflation surprises.
• Higher US rates together with a stronger DXY, which the report sees as the most unfavorable combination for EM.
• A rebound in rate volatility from low levels, weakening the low-volatility environment that had previously supported EM.
• Asia and Europe are hit harder by energy prices while US growth remains relatively resilient.
• Inflation, wage, food price, and fiscal revenue risks rise in South Africa.
• Localized political risk, election risk, and external debt spread volatility in LatAm and EEMEA.
• Some trades are crowded, such as Hungarian local bonds, which may weaken risk-reward.

What to watch

• Fed policy signals and shifts in market pricing for the next hike or cut.
• DXY and the shape of the US yield curve, especially whether a bear-flattening scenario emerges.
• Oil price moves and their asymmetric impact on Asia, Europe, and EM energy importers.
• Whether global inflation data continue to surprise to the upside in May and June.
• Chinese exporter FX conversion, USDCNY, PBoC fixing, and dividend-related FX demand from June to August.
• South Africa's May 29 MPC, July inflation expectations survey, breakevens, and wage negotiations.
• Costa Rica's new government's fiscal rule implementation, tax revenue, external issuance legislation, and tourism growth.
• LatAm election developments, especially Colombia, as well as Banxico policy and inflation breakevens.
• Sovereign spread performance of the Dominican Republic relative to Guatemala and Costa Rica.