The risk of the Federal Reserve raising interest rates is dragging down market sentiment, and the decline in bonds has spread to emerging markets.

As concerns about the likelihood of the Federal Reserve raising interest rates this month have become the dominant factor influencing market sentiment, overshadowing the impact of the Middle East conflict and volatility related to artificial intelligence (AI), a global bond sell-off has spread to emerging marketsfrom South Africa to South Korea and Poland, where the yields on 10-year government bonds have all risen. Among them, South Africa, seen as a bellwether for emerging market assets, led the bond market decline among major emerging markets on Tuesday. Data showed that the yield on South Africa's 10-year government bond rose by 9 basis points to 8.83%, the highest level since July 24. Similar-duration bond yields in South Korea, Indonesia, and Latvia also increased by 5 basis points. Meanwhile, data from J.P. Morgan indicated that the risk premium for emerging market U.S. dollar bonds rose by 6 basis points to 235 basis points on Monday. The prices of credit default swaps (CDS) for 30 sovereign issuers from developing countries rose for the fourth consecutive day, marking the longest uninterrupted increase since April. Money market data showed that the market currently believes there is nearly a 70% probability that the Federal Reserve will raise its benchmark rate by 25 basis points on September 16. This pricing is driven by hawkish signals released by Federal Reserve Chairman Kevin Warsh at the Jackson Hole central banking conference last week. Warsh stated that inflation in the United States has not meaningfully slowed down, and the Federal Reserve may need to take action. Since reaching a historic high on August 25, emerging market local currency bonds have continued to decline. Concerns over persistently high inflation and the hawkish stance of the Federal Reserve have weakened investors' interest in risk assets. Although the rally in AI stocks continues and investors remain optimistic about the carry trade prospects in developing countries, emerging market local currency bonds are still declining. However, some asset management firms suggest that global investors are pushing to diversify their portfolios away from U.S. dollar-denominated assets, which could soon attract capital inflows again, providing support for bond prices. Pessimism has also spread to the foreign exchange market, with most emerging market currencies experiencing declines. The Indian rupee and the New Taiwan dollar saw slight increases, while the South Korean won, Hungarian forint, Malaysian ringgit, and Israeli shekel were among the worst-performing currencies. Simon Quijano-Evans, a senior emerging market strategist at Macro Hive, wrote in a report: "Emerging market forex remains in a relative value mode, digesting Warsh's comments from last Friday. The market is effectively doing the central banks' job. So, will the market now start to expect that the Fed and other central banks will once again buy bonds?" Emerging market stocks continued their upward momentum. The MSCI Emerging Markets Stock Index rose by 0.3% on Tuesday, following its largest monthly gain since 2004 in August. TSMC contributed 66% of the index's increase. Investor confidence in Taiwanese AI companies was boosted after Nvidia's $3.5 billion investment in MediaTekits largest direct investment outside the U.S. As September begins, new bond issuance activities are set to become active again. Saudi Arabia is marketing benchmark-sized dollar-denominated Islamic bonds with maturities of 5 and 10 years. Pakistan is also holding investor calls in preparation for issuing long-term 5-year and 10-year bonds. The Bank of Israel faces a difficult decision on interest rates on Tuesday, with economists divided on whether the central bank will cut rates for the third consecutive time or maintain them. Israeli policymakers will seek to balance moderate inflation and a strong shekelbenefiting from the current lull in direct conflict between Israel and Iranwith the potential fiscal pressures that may mount before the October elections.