By Laurence Fletcher

Hedge funds are expecting areas including emerging markets, Italian bonds and the dollar to throw-up enticing trades in 2017.

Last year was hard going for many funds. Managers have blamed trillions of dollars of central bank stimulus for distorting markets.

Now, many managers are hoping the effects of quantitative easing are fading. Instead, rising bond yields, U.S. President-elect Donald Trump's plans to cut back bank regulation, elections in Europe and greater market differentiation between stocks are being cited as reasons for optimism.

Here are three areas hedge funds say they will be focusing their attentions:

Macro trading

Macro traders--who bet on moves in bonds, currencies and stocks--have fared terribly in recent years as central bank stimulus has helped push bond yields much lower than most managers expected.

These funds posted only their second calendar year of profits since 2010 last year, a tiny gain of just 1.49%. But that masks a dramatic improvement in performance among many funds--such as Brevan Howard and Rubicon--in the last two months of the year, helped by a big rise in bond yields and the dollar.

Central banks' waning influence "means all the issues that have been moved under the carpet will resurface and we'll have to face them over the next two-to-three years," which will create trading opportunities, said Michele Gesualdi, chief investment officer at Kairos Investment Management, which invests in hedge funds and runs around $10 billion in assets. He said he plans to increase his exposure to macro funds, which in November helped it post its best monthly performance in 15 years.

The U.S. election has "launched nothing short of a sea change in the potential opportunity set for trading markets globally," wrote Louis Bacon, who runs New York-based Moore Capital, one of the world's biggest and oldest macro funds, in a recent letter to investors reviewed by The Wall Street Journal.

"Whether Trump fails or succeeds in his plan to 'Make America Great Again', he is certainly going to be making macro trading/investing great again," he added.

Europe

Managers are licking their lips at 2017's calendar of European events, including elections in France, Germany, the Netherlands and possibly Italy.

The events themselves can prove unpredictable and tough to bet on. But they offer possible catalysts to expose European economic problems, which many funds have predicted for years.

Among funds to be playing this theme are Brevan Howard, Moore and Caxton, said a personfamiliar with the matter.

Italy is a focus, due to its high debt, weak economy and political uncertainty. Trades include betting on the difference between bond yields in Italy, where the 10-year yield is around 1.9%, and the U.S., where the 10-year is 2.3%. Or some funds are trading the difference between U.S. and German bonds or between U.S. and a basket of European bonds.

"Europe is definitely a story for 2017," said Anthony Lawler, portfolio manager at GAM. "But it's not clear yet what the trade is" given the significant political and economic uncertainties."

Emerging markets

Last year was a strong year for emerging market funds. The Russian Prosperity fund gained 58%, for instance, while Sagil Latin American Opportunities was up 30.6% last year, according to a letter to investors, its best year of performance since launch in 2009. The fund is betting on Mexican real-estate companies and Brazilian farming firms this year, according to the letter.

Managers see further trading opportunities, particularly if Mr. Trump's policies affect global trade. "Asian currencies have been the biggest beneficiaries of open trade," said Kairos's Mr. Gesualdi.

Louis Bacon pointed to "a continued rally in the U.S. dollar" which "should throw up trade opportunities in commodities and emerging markets, most obviously" in his letter to investors.

Hedge funds are running large bets against the Mexican peso versus the dollar but are betting on the Brazilian real rising, according to data from the U.S. Commodity Futures Trading Commission.

Write to Laurence Fletcher at laurence.fletcher@wsj.com

(END) Dow Jones Newswires

January 12, 2017 07:51 ET (12:51 GMT)

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