Emerging Market Losses Deepen as Treasury Yields Edge Towards 5%

Losses in emerging-market stocks and bonds deepened as the rise in US Treasury yields and concern about a wider conflict in the Middle East pushed investors to unload riskier assets.

(Bloomberg) — Losses in emerging-market stocks and bonds deepened as the rise in US Treasury yields and concern about a wider conflict in the Middle East pushed investors to unload riskier assets.

This week’s losses on the MSCI benchmark equity index have surpassed 2%, while most currencies are also trading weaker. Foreign-exchange markets most correlated with the global macroeconomic outlook — the South Korean won and the South African rand — were among the biggest laggards.

Yields on 10-year US government bonds gained for a fourth day, coming closer to reaching 5% for the first time since 2007. That is increasing the valuation pressure on emerging market assets, which typically lose their appeal when the US dollar strengthens and US rates rise.

“Being the benchmark rate for any investment, higher US Treasury yield increases the return expected for any other investment, either equities, real estate, or bonds,” said Omar Ghalloudi, head of emerging-market trading at KNG Securities. “Meeting these higher returns requires asset prices to adjust downward.”

Federal Reserve Chair Jerome Powell suggested the US central bank is inclined to hold interest rates steady again at its next meeting while leaving open the possibility of a future hike if policymakers see further signs of resilient economic growth.

Hungary has registered one of the biggest jumps in yield in the region, with 10-year notes climbing 7 basis points to 7.68%. Poland’s markets, which had rallied earlier in the week on the prospect of a pro-European Union coalition taking power, are now paring gains. 

In commodities, oil prices fluctuated as the US eased crude sanctions against Venezuela, while UK Prime Minister Rishi Sunak arrived in Israel in a bid to prevent the conflict with Hamas from spreading across the Middle East. 

Meantime, Moody’s Investors Service put Israel’s rating on review for downgrade, citing the “unexpected and violent conflict between Israel and Hamas.”

“The severity of the current military conflict raises the possibility of longer lasting and material credit impact,” analysts Kathrin Muehlbronner and Dietmar Hornung wrote in a Thursday statement. “The review will focus on the likely duration and scale of the conflict, and on assessing its implications for Israel’s institutions, in particular the effectiveness of its policymaking, its public finances and the economy.”

Elsewhere, Egyptian stocks rallied to fresh highs this week even as tensions escalated in the Middle East, as local investors poured in to hedge against expectations of another currency devaluation and record inflation. In Sri Lanka, the government said it’s taking an unfavorable view toward a proposal by foreign dollar bondholders for restructuring its debt, signaling possible complications in negotiations.

Yields on junk-rated EM dollar debt continued to climb, reaching 12.1%, the highest in almost a year, according to a Bloomberg index. The losses in investment-grade EM dollar debt reached 2.2% year-to-date, showing even safer category bonds are not immune from the selloff amid the 11th week of outflows in a row, according to Bank of America strategists citing EPFR Global data from last week. 

This is renewing concern about debt defaults in emerging markets.

“As a consequence of higher borrowing costs and lower expected revenues, default probabilities for most credits increase, which translates into larger risk premiums, that compound the initial effect of the rise in rates of the other assets,” said Ghalloudi.

In Latin America, persistent upward pressure in US Treasury yields is weighing on currencies, with the Mexican peso down 1.3% for the week. 

–With assistance from Cristin Flanagan.

(Adds Powell comments in fifth paragraph, adds Moody’s on Israel in paragraphs eight and nine, updates Mexican peso move in last paragraph.)

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