US Treasury yields surge impacts emerging Asia! Bond spreads approach record lows, capital outflow risks heat up.

Strategists said 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 surged 16 basis points on Wednesday to 5.11%, the highest since 2007. This widened the yield discount of Malaysia's 10-year government bonds relative to US Treasuries to the deepest level since 2007, while spreads in Indonesia and Thailand are also approaching record lows. Stephen Chiu, chief emerging-market FX strategist at BI, said, "Longer-dated emerging Asian bonds are especially vulnerable to higher US Treasury yields, particularly in low-yield markets such as South Korea and Thailand." Rising US Treasury yields could "either trigger foreign capital outflows or reduce net foreign inflows into the region's bonds." For emerging Asia, widening 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 push up borrowing costs. By contrast, yields in emerging Asia rose only modestly on Thursday, up 5 basis points in Malaysia and Thailand, benefiting from stable domestic inflation and resilient local currencies and avoiding the severe selloff seen in US Treasuries. This week, the discount on Malaysia's 10-year government bonds relative to US Treasuries widened to 122 basis points, the deepest since 2007; the equivalent spread for Thailand's 10-year government bonds reached 290 basis points, approaching a record low. Earlier this month, the spread between Chinese and US 10-year government bonds also widened to the widest level on record, while the spread between Indonesian government bonds and US Treasuries narrowed to 196 basis points, approaching a historic low. "The relentless upward trend in US Treasury yields does present an unsettling backdrop for bond investors," said Homin Lee, senior macro strategist at Lombard Odier Singapore. "But it also reveals the resilience of Asia's dollar and local-currency bond markets, with the exception of the more fragile Indonesia and the Philippines."