US Treasury yields have climbed to near two-decade highs, oil prices remain volatile, and the situation around the Strait of Hormuz continues to be unclear, pushing emerging market bonds toward their worst monthly decline since the Iran war began, with capital outflows unlikely to reverse in the near term.
On Monday, emerging market stocks and currencies extended their recent sell-off. With borrowing costs surging broadly, the MSCI Emerging Markets Equity Index fell 1.1% on the day, and nearly all developing-nation currencies weakened against the US dollar, significantly weighing on market risk appetite.
Outflows from the bond market were particularly severe. Last week, the US$13 billion BlackRock iShares J.P. Morgan Emerging Markets USD Bond ETF recorded US$610 million in outflows, the largest weekly outflow since March and the fastest pace of capital withdrawal in six months.
Market sentiment remains fragile as uncertainty over the reopening of the Strait of Hormuz triggers sharp swings in oil prices. Although reports suggested that Trump may be willing to offer Iran sanctions relief and release frozen funds in exchange for progress on its nuclear program, prompting crude prices to retreat from nearly US$110 per barrel to around US$105, the broad pressure on emerging market assets has not eased under the dual burden of high interest rates and elevated oil prices.
Yield surge amplifies capital outflows
The sustained sell-off in the US Treasury market is the core driver of this emerging market turbulence.
Buoyed by data released last Wednesday showing US business activity expanding at its fastest pace in more than five years, long-term Treasury yields approached multi-year highs. The 10-year Treasury yield broke through 5.20%, hitting a near two-decade high, while the 30-year Treasury yield also climbed last Thursday to its highest level since 2004.
William Castro Alves, chief strategist and partner at Brazilian investment firm Avenue, said that rising US borrowing costs are "pushing yields higher across the entire curve," while elevated oil prices and resurgent inflation concerns are also weighing heavily on the asset class.
Todd Sohn, chief ETF strategist at Baird Strategas, added that with the combination of high rates and high oil prices, the market has effectively entered risk-off mode, and emerging market debt is not a good asset allocation choice in this environment, with outflows expected to continue.
According to Bloomberg data, the Bloomberg EM Hard Currency Aggregate Index has fallen about 2.1% in September.
Equity and currency fundamentals under pressure
In the equity market, MSCI's developing-nation stock gauge is heading for its worst single-day performance in nearly two weeks.
Asian tech stocks were the main drag on Monday, with Samsung Electronics and SK Hynix leading declines. Meanwhile, MSCI's Latin America equity gauge also fell about 1%. Still, both indices remain up 22% and 11.3% respectively year-to-date.
Guy Miller, chief market strategist at Zurich Insurance, noted that as market expectations for Federal Reserve policy become more hawkish, investors' appetite for riskier assets has diminished.
He said emerging markets are being pulled by two forces: on one hand, the technology sector remains strong, offering investors clear earnings expectations and profit margins; on the other hand, the interest rate trajectory from the US is disruptive and will pose a powerful headwind for other sectors over the medium term.
In currency markets, the Colombian peso led declines with a 1.5% drop. Earlier, the country's new president, Abelardo de la Espriella, announced in a national address on Sunday evening that he had ordered his economic team to begin negotiations with the International Monetary Fund (IMF).
The government is currently facing what officials describe as the worst fiscal crisis in the country's history.