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U.S. President-elect Donald Trump appears to have burst the bond bubble, putting emerging markets (EM) from Mexico to Indonesia at the sharp end of a sell-off.
Expectations of fiscal stimulus, infrastructure spending and reflationary policies under a Trump administration were fueling inflation fears, sending benchmark U.S. ten-year Treasury yields and surging. Expectations for tighter monetary policy and a December rate hike by the Federal Reserve were also playing a role.
In the wake of last week's election outcome, the U.S. 10-year Treasury yield climbed above 2 percent from levels below 1.8 percent in the days before the result, with many analysts pointing to expectations that Trump's promised policies would spur a resurgence of inflation and further interest rate hikes from the U.S. Federal Reserve.
That created a negative feedback loop for emerging market assets.
Indonesia's rupiah fell by as much as 3 percent against the dollar on Friday to five-month lows, hurting local stocks, with the declines extending on Monday. Malaysia's ringgit also fell to its lowest against the dollar since late 2015, near levels not seen since the Asian Financial Crisis in 1998.
Central banks last week in Malaysia and Indonesia intervened to support their currencies, while foreign investors have slashed holdings of sovereign EM bonds perceived as most risky.
Analysts were rejigging their outlook for Asian bonds.
"Asian fixed income assets have operated on a 'lower for longer' assumption' for U.S. rates since June," RBS economists led by Vaninder Singh wrote in a note on Friday. "This assumption is being challenged. High-yielding currencies will have to re-price to become attractive again."
It wasn't clear how long that process will take and how painful the adjustment would be.
"The thing to watch will be capital flows, as a good amount of money has shifted into EMD [emerging market debt]," Rick Rieder, CIO for global fixed income at Blackrock, said on Thursday. "It will be important to see if investors have the patience and wherewithal to stick out any near-term headline risks."
Foreign holdings in EM debt will be a key factor.
Within Asia, foreign ownership of sovereign bonds is highest in Indonesia and Malaysia, at just over 38 percent and 36 percent respectively. That has meant the impact of expectations for higher U.S. interest rates on the rupiah and ringgit "will take some time to fully play out," RBS's economists said.
High-yielding Indonesian and Malaysian debt was most at risk from an unwind in capital flows as higher U.S. rates make outstanding dollar-denominated debt more expensive to service, raising possible default risk.
Rajeev de Mello, head of Asian fixed income at Schroders, said the two sovereigns bore the brunt of the sell-off because they were key components of broader emerging market bond indexes.
Some analysts expected uncertainty over Trump's election would continue to weigh emerging market assets.
Friday's rout in emerging market debt and currencies may just be Act One, Adam Reynolds, Saxo Capital Markets' Asia Pacific CEO, told CNBC's "Street Signs" on Friday. The price action at the tail-end of last week, when the rupiah dropped 3 percent and the JPMorgan EM Bond Index slumped 5 percent, suggested the beginning of a "meltdown" in those assets, Reynolds warned.
Others were also concerned the sell-off would continue.
Jason Daw, a strategist at Societe Generale, said in a note Monday that the emerging-market currency selloff was of "epic proportions." He added that with "real money" still modestly short the dollar, there was plenty of scope for the emerging-market currency selloff to accelerate.
"We believed that a Trump victory had scope for investors to re-evaluate their emerging-market thesis, and indeed this appears to be what is occurring," with the rise in U.S. Treasury yields compounding the moves, Daw said.
"Coupled with the protectionist bias of president-elect Trump, investors are becoming increasingly concerned about the future prospects of emerging markets. The worry is that stronger U.S. growth will have a smaller impact than previously on emerging market growth under a protectionist president," he added.
CIMB echoed that view in a note dated Sunday.
"Threats of anti-trade measures and 'ripping up' of trade agreements are both inflationary for the U.S. and negative for trade-exposed economies, such as Malaysia," CIMB said. "Antagonizing China in accusations of currency manipulation and heightened geopolitical tensions in Asia are also raising the 'Trump risk premium' for the currencies of emerging markets."
CIMB noted that while EM bonds still offered a yield premium over U.S. counterparts, that had been narrowing, which had spurred investors to unwind any carry trades funded by dollars. Carry trades are trades that involve borrowing in one — usually low-yielding — currency and buying assets in a higher-yielding currency.
HSBC, however, offered some comfort.
Although the early bout of selling did look indiscriminate, emerging markets with strong domestic growth profiles and structural reform momentum may provide a degree of insulation for investors, HSBC said in a note on Friday.
Foreign appetite for EM bonds may return to markets with "positive local factors," such as India, Indonesia, Brazil and Russia, though demand may take a hit in the near term, according to the bank.