Why has aggressive US interest rate hikes dampened emerging market bonds?

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Aggressive US Rate Hikes Dampen Emerging Market Bond Appeal Due to Narrowing Yield Differentials

Aggressive interest rate hikes by the US Federal Reserve have diminished the attractiveness of emerging market bonds, including Malaysian Government Securities (MGS). This reduction in appeal stems from a narrowing yield differential between US Treasury bonds and MGS, making ringgit-denominated bonds less appealing to foreign investors. The sustained hawkish stance of the Fed has led to significant increases in US Treasury yields, which have begun to outpace the rise in MGS yields, creating a less favourable investment environment for those seeking higher returns in emerging markets.
Understanding Emerging Market Bonds and Investor Base

Emerging market bonds represent debt issued by governments or corporations in developing economies. These markets are typically sought by investors looking for higher yields compared to those offered by developed nations, though they often come with higher perceived risks. Investors in these markets can include institutional funds, such as pension funds and asset managers, as well as individual investors who access these markets through various investment vehicles. The appeal of these bonds is often driven by attractive interest rate differentials that compensate for the increased risk.
The Impact of US Federal Reserve's Hawkish Stance

The US Federal Reserve's "hawkish stance" signifies its commitment to controlling inflation, often through raising interest rates. This policy approach involves increasing the target for the federal funds rate, which influences borrowing costs across the US economy. In the year to date, the Fed has implemented a series of aggressive rate increases, totalling 300 basis points. This sustained tightening of monetary policy aims to cool down an overheating economy, but it also has significant implications for global capital flows and the relative attractiveness of different investment markets.
Yields and Basis Points Explained

In financial markets, "yield" refers to the return an investor can expect from a bond, typically expressed as an annual percentage of the bond's face value. "Basis points" (bps) are a common unit of measure for financial rates and yields, where one basis point is equal to 0.01 per cent. For instance, a 68.0 basis point increase in the 10-year US Treasury yield means it rose by 0.68 per cent. As of the end of September, the 10-year US Treasury yield had climbed to 3.83 per cent, while the 10-year MGS yield had risen to 4.44 per cent, an increase of 45.7 basis points.
Narrowing Rate Differentials and Foreign Investment

The widening gap between US Treasury yields and MGS yields has historically provided an incentive for foreign investors to allocate capital to Malaysian bonds. However, with US Treasury yields rising more sharply than MGS yields, this differential has narrowed significantly. In September, the 10-year US Treasury yield increased by 68.0 basis points to 3.83 per cent, while the 10-year MGS yield rose by 45.7 basis points to 4.44 per cent. This narrowing gap reduces the relative advantage of holding ringgit bonds, leading to a decrease in foreign demand, evidenced by RM2.5 billion in net outflows from Malaysian Government Securities and Conventional Government Investment Issues in September. This trend of US Treasury yields outpacing MGS yields continued into October, further dampening foreign investor interest.

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Why has aggressive US interest rate hikes dampened emerging market bonds?

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