EM assets retreat as bond yields spike

Emerging markets are bracing for a possible exodus of funds as a surge in US Treasury yields evokes memories of the “taper tantrum” of 2013.

After rallying at the start of 2021, developing-nation assets slumped late last week as Treasury yields jumped to the highest level in more than a year, sounding a warning about the outlook for interest rates and inflation. The MSCI Emerging Market Index of shares tumbled 2.8% on Friday alone.

Emerging-market assets are falling out of favour as expectations for tighter global monetary policy and a revival of inflation reduce the relative appeal of risk assets.

Last week’s surge in US yields is reminding many of the taper tantrum of 2013, when the Federal Reserve’s announcement that it would start scaling back its massive bond-buying programme led to a spike in bond yields around the world.

“It appears the market is pricing in a taper tantrum whatever the Fed says,” said Alvin Tan, head of Asia foreign-exchange strategy at RBC Capital Markets in Hong Kong. “Like in 2013, it is generally negative for emerging market forex”, he said, with the Indonesian rupiah, South African rand, Turkish lira and Brazilian real among the most vulnerable currencies.

It’s quite a turnaround from January, when two-thirds of investors surveyed by Bank of America ranked emerging markets among the most favoured trades for this year.

“We could be at a tipping point where the rise in yields could become more problematic for the broader market,” said Sim Moh Siong, a currency strategist at Bank of Singapore. “It’s never good news for countries with current-account deficits. Rising yields mean the cost of external financing has become higher.”

The jump in borrowing costs may create a challenge for many developing economies as they seek to finance the funds spend to combat the impact of the pandemic. Indonesia missed its goals at its last two bond auctions. India is also considering borrowing less to ease the pressure on its debt market, sources said.

Emerging-market authorities may be forced to increase bond buying to keep a lid on yields, said Mitul Kotecha, a strategist at TD Securities in Singapore.

“They will not want to see a premature rally in yields, especially as growth ... is still fragile,” he said. “Higher market volatility, pressure on yield differentials and a slide in growth and momentum stocks will likely hurt EM assets.”