The surge in US Treasury yields to decade-high levels is threatening the carry trades that had become the dominant strategy for emerging-market investors this year. Citigroup Inc. closed its carry basket that included long positions in the South African rand, Mexican and Colombian pesos, and Turkish lira against the Canadian dollar and Swiss franc. According to Bloomberg, the move came after a strong US PMI report, a weak 5-year Treasury auction, and geopolitical headlines stoked market volatility. A Bloomberg index measuring cumulative carry returns for eight major developing-nation currencies is set for its biggest monthly decline since March, down almost 1%. Favored currencies for the trade, like the Colombian and Mexican pesos, have underperformed significantly, with Colombian peso down 6.6% and Mexican peso down 2.6% since the Federal Reserve hiked interest rates last week.
The surge in Treasury yields has pushed yield gaps with emerging Asia bonds toward record levels, raising the risk of capital outflows from the region. Malaysia's 10-year yield discount to Treasuries widened to 125 basis points, the most since 2007, while Thai 10-year bonds reached 290 basis points, nearing a record low. As reported by Bloomberg Intelligence, longer-dated EM Asia bonds are particularly at risk from higher Treasury yields, especially low-yielders such as South Korea and Thailand. The China-US 10-year yield gap also widened to the most on record earlier this month, while Indonesia's spread over Treasuries narrowed to 188 basis points, approaching an all-time low. By comparison, yield moves in emerging Asia have been more modest, rising by only 7 basis points in Malaysia and Thailand on Thursday.
The local-currency emerging-market bond market has reached $6.7 trillion as of August 2025, dwarfing its dollar-denominated counterpart at approximately $1 trillion. According to JPMorgan, local EM bonds delivered returns between 9% and 19% in USD terms across major indices in 2025, marking their best performance since 2019. This outperformance comes as rising US Treasury yields continue to push global investors away from dollar-denominated emerging-market debt toward local-currency alternatives, though current market conditions are testing this trend.
A Bank of America Corp. survey of 38 global fixed-investment fund managers overseeing $444 billion in combined assets revealed significant positioning changes. As reported by The Economic Times, 84% of respondents were overweight local EM debt relative to hard currency bonds, compared to just 38% in August. The poll was conducted between September 4 and 9, showing a marked increase in local currency debt preference. However, Bank of America is now among those turning increasingly cautious on developing-world currencies, warning that positioning is getting stretched.
JPMorgan announced its GBI-EM Edge frontier local-currency government bond index, set for launch by the end of September 2026. The index will track approximately $330 billion in debt across 26 countries, with Africa commanding a notable weighting of around 45%. The average nominal yield on the index sits at roughly 10.4%, while JPMorgan's existing GBI-EM Global Diversified index returned 0.90% in USD terms in August 2026, reflecting broader dollar weakness and continued positive inflows into local-currency EM bond funds.
The carry trade disruption highlights the volatility sensitivity of these strategies during high crowding periods, as noted by Citigroup analysts. Raghav Adlakha, a strategist at Bank of America Corp, stated that "For carry to keep performing, we need rates volatility to head lower and, ideally, US rates to remain range-bound." The case for local-currency EM bonds rests on several key pillars, including domestic institutional ownership where countries with pension funds and banks dominate the investor base exhibit lower volatility. However, current market conditions suggest that global inflation concerns fueled by higher oil prices are forcing a rethink of traditional carry trade strategies, with analysts noting that oil below $100 could provide conditions for the theme to return. As noted by Lombard Odier Singapore, "The relentless uptrend in US yields does provide an uncomfortable backdrop for bond investors, but it also revealed the resilience of USD and local debt markets in Asia, with the exception of more vulnerable Indonesia and Philippines."
