US Treasury yields surge hits emerging Asia! Bond spreads approach record lows, raising capital outflow risks

According to Smart Finance APP, several strategists have stated that the surge in US Treasury yields has pushed the spread between emerging Asian bonds and US Treasuries to record levels, increasing the risk of capital outflows from the region.

Driven by strong economic data and weak auction demand, the 10-year US Treasury yield soared by 16 basis points on Wednesday to 5.11%, the highest since 2007. This has widened the yield discount of Malaysia's 10-year government bonds relative to US Treasuries to its deepest level since 2007, while the yield spreads of Indonesia and Thailand are also approaching record lows.

BI Chief Emerging Markets FX Strategist Stephen Chiu said, "Longer-dated emerging Asia bonds are especially vulnerable to the shock of rising US Treasury yields, particularly in low-yield markets such as South Korea and Thailand." The rise in US Treasury yields could "either trigger foreign capital outflows or reduce the net foreign inflows into the region's bonds."

For emerging Asia, the widening of spreads and potential capital outflows could bring a series of consequences, including downward pressure on local currencies. Regional central banks may then be forced to keep domestic interest rates high to defend their currencies, which in turn could drive up borrowing costs.

By contrast, emerging Asian yields rose only moderately by 5 basis points in Malaysia and Thailand on Thursday, benefiting from stable domestic inflation and resilient local currencies and thus avoiding the heavy sell-off suffered by US Treasuries.

This week, Malaysia's 10-year government bond discount relative to US Treasuries widened to 122 basis points, the deepest since 2007; while Thailand's comparable 10-year yield spread reached 290 basis points, approaching its record low.

Earlier this month, the China-US 10-year government bond spread also widened to its highest level on record, while Indonesia's bond spread over US Treasuries narrowed to 196 basis points, close to historical lows.

"The ongoing upward trend in US Treasury yields does provide a disquieting backdrop for bond investors," said Homin Lee, Senior Macro Strategist at Lombard Odier Singapore. "But it also highlights the resilience of Asian dollar and local currency bond markets, with the exception of more vulnerable Indonesia and the Philippines."