A significant surge in US Treasury yields is putting pressure on the emerging markets (EM) carry trade, prompting some major financial institutions, such as Citi, to reportedly scale back their exposure. On Wednesday, the 10-year Treasury yield jumped 16 basis points to 5.11%, its highest level since 2007. This sharp increase makes US bonds more attractive to investors, potentially drawing capital away from higher-yielding but riskier EM assets.
The widening gap between US Treasury yields and EM Asia bonds is a key concern. For instance, Malaysia's 10-year bonds are now trading at their deepest discount to Treasuries since 2007, with the gap widening to 122 basis points. While Thailand's 10-year spread compressed to 290 basis points and Indonesia's to 196 basis points, both are near all-time lows. This indicates that despite local stability in some EM countries, the sheer rise in US yields creates an "uncomfortable backdrop" for bond investors, according to Homin Lee of Lombard Odier Singapore. Stephen Chiu, Bloomberg Intelligence's chief emerging markets FX strategist, warns that longer-dated EM Asia bonds, especially low-yielders like South Korea and Thailand, are particularly at risk from higher Treasury yields, potentially leading to foreign outflows or reduced inflows.
The overall bond market rout, driven by robust US economic data and weak demand at Treasury auctions, has pushed yields across much of the curve to their highest levels in almost two decades. The 10-year yield steadied at 5.12% in Asian trading after a 15-basis-point surge on September 23, the biggest since April 2025. This environment of rising US yields can sap demand for some EM Asia bonds, pressure certain currencies, and force regional central banks to keep policy rates elevated to support exchange rates. The 30-year Treasury yield also touched roughly 5.44% on Thursday, its highest since 2004.
The "uncomfortable backdrop" mentioned by strategists is already manifesting in market behavior. Hedge funds, for example, are reportedly souring on the basis trade, with funds locked in leveraged basis trades down 20% this year to $1.2 trillion, according to Morgan Stanley. This shift reflects a broader unease and repricing of risk as the market anticipates a "genuine re-tightening cycle," leading to higher discount rates for equities, increased mortgage and corporate borrowing costs, and a higher bar for risk assets globally.
