LONDON: A stronger dollar and slowly rising US Treasury yields saw emerging market borrowing costs hit their highest level in nearly nine months on Tuesday while equities snapped a three-day winning streak in thin trading.
MSCI's emerging market index eased 0.3 percent with Russian dollar-denominated stocks chalking up some of the biggest losses, falling more than 1 percent. However, trading was light as many markets in Asia, emerging Europe and Latin America were closed due to the May Day holiday.
The losses came after the dollar rose 0.3 percent to a fresh 3-1/2 month high against a basket of currencies, and US 10-year Treasury yields nudging higher again.
Meanwhile pressure also rose on the premium demanded by investors to hold emerging market hard-currency debt. The average yield spread on the JPMorgan EMBI Global Diversified index rose to 311 basis points - its highest level since mid-August 2017.
"The real driver is the movement in US 10-year yields," said Kiran Kowshik at UniCredit, adding the recent surge in oil prices had pushed up inflation expectations.
Yet with overall financial conditions still lose, the Fed was unlikely to push back on higher yields for now while growth indicators pointed to a slowing momentum, he added.
"That means US yields go up, and if PMIs (Purchasing Managers Indicator) stabilise or move lower, that's a slightly negative backdrop for emerging market currencies."
The Federal Reserve is expected to keep interest rates on hold at its two-day policy meeting starting later on Tuesday, with a June hike already priced in.
But the strong greenback weighed on emerging currencies, with South Africa's rand slipping 0.8 percent to hit its weakest level since late December while Turkey's lira nearly matched those falls.
The Turkish central bank pledging its commitment to simplify its interest structure on Monday did little to soothe investors nerves while policy makers focussed on stabilising markets ahead of the June election, said Kowshik.
"They need to talk about something to satisfy markets and show they are moving to more orthodox policy, hoping that maybe the market will give them the benefit of the doubt on that," he said. "When you get to the second half of the year, the currency comes under pressure again.
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