By Craig Mellow 

Searching for yield in a low-return world? How about Brazil? The central bank there has hiked interest rates from 2% to 7.75% this year, and 10-year local-currency bonds yield north of 11% annually. Mexican rates have climbed from 4% to 5% since May. Poland hiked from 0.1% to 1.5% over the past two months. And so on.

"This is the first time in 35 years I have seen EM central banks lead the way on tightening," says David Robbins, an emerging markets debt portfolio manager at TCW.

He and other managers are not piling into the bonds just yet, though. Maybe next year. The iShares JP Morgan EM Local Currency Bond exchange-traded fund (ticker: LEMB) is down more than 7% since Sept. 1, a vertiginous drop for fixed-income.

Other things being equal, a widening gap between U.S. and foreign interest rates should rekindle the so-called carry trade: investors borrowing in dollars (or euros) and redeploying into real, pesos, or zlotys. But other things are far from equal as the world struggles to emerge from Covid-19 without reigniting runaway inflation.

The emerging-market rate increases are barely keeping pace with price rises, and inflation there looks stickier than in developed markets. U.S. and Mexican inflation are both about 6% currently. A year from now, markets project the U.S. at 2.5%, with Mexico stuck at 4.5%, says Phoenix Kalen, head of emerging markets research at Societe Generale. That dampens return expectations.

Investors are instead accentuating the negative for emerging markets. Federal Reserve hints of tightening to come bolster the dollar and evoke memories of the "taper tantrum" that crashed emerging markets in 2013. "This whole year has been a taper tantrum in fits and starts," Kalen says.

The countries hiking most aggressively are also long on political risk. Brazil faces an election next year between two bad alternatives, from the markets' point of view: incumbent president Jair Bolsonaro and leftist ex-president Luiz Inacio Lula da Silva.

The peso slid to an eight-month low this week on Mexican President Andres Manuel Lopez Obrador's out-of-left-field choice for central bank governor.

And Russia was a capital magnet for much of this year on rate hawkishness and energy prices. Now it's tumbling as Vladimir Putin masses armies against Ukraine. The ruble is down 8% against the dollar over the past month, burning bondholders.

Asia is offering less immediate risk, and less reward. Regional giants India, Indonesia, and Philippines are all holding steady near record-low interest rates.

Next year could be better, investors say, with inflation cooling and emerging markets' interest rates peaking, just as the Fed starts hiking interest rates for real. Rising rates are bondholders' enemy. "Once we see peak inflation, the carry trade could come back with force," says Luc D'hooge, head of emerging markets bonds at Vontobel's Fixed Income Boutique.

D'hooge is expecting that happy moment to come in spring of 2022, an educated guess at best. Another precondition: continued cooling of U.S. economic growth -- the third-quarter rate was 2.1% year-on-year -- while emerging markets accelerate out of the pandemic. "People like to see the growth differential with the developed world increasing, not decreasing, as it has been," D'hooge says.

A lot of ifs. "It could be darkest before the dawn," SocGen's Kalen says. Or the night could last awhile.