Bets on higher-yielding currencies from Indonesia to Brazil are unwinding at the fastest pace since 2011 as soaring US Treasury yields undermine the case for riskier government debt.
A Bloomberg gauge of the carry trades in eight developing-nation currencies tumbled 3.8 per cent over the past two days last week as the yield advantage on emerging- market bonds narrowed to a 16-month low.
It is an abrupt reversal for a strategy that had rewarded foreign exchange traders for much of the year, pushing the index of carry trade returns to an 18-month high last Tuesday. The rise in US Treasury yields, fuelled by expectations that Mr Donald Trump's spending plans will boost inflation and swell the US budget deficit, deals another blow to emerging markets already bracing themselves for a wave of protectionist policies from the President-elect.
"The probabilities don't look so good for emerging-market currencies until we get stability around Treasury yields and some reduction in uncertainty around the new president," said Mr Matt Sheridan, a money manager at AllianceBernstein in New York.
"The potential for capital to move away from emerging-market currencies has increased."
The South African rand, a popular carry-trade currency because of its high local interest rate, was the biggest casualty in emerging markets last Friday, slumping 2.3 per cent against the US dollar. The Indonesian rupiah dropped as much as 3 per cent in Asian hours, before paring losses to 1.1 per cent after the nation's central bank stepped in to stabilise the market.
In India, state-run banks sold US dollars on behalf of the country's monetary authority, said two Mumbai-based traders. The rupee lost 0.9 per cent.
Brazil's real, another favoured carry-trade currency, sank almost 5 per cent last Thursday.
While yields in emerging markets are still higher than those in the United States, the gap has been shrinking.
The so-called spread between JPMorgan's GBI-EM Global Diversified Composite Index and 10-year US Treasuries narrowed to 4.41 percentage points last Wednesday, the smallest since July 2015.
Mr Trump's promises to get tough on trade have also weighed on emerging markets. On the campaign trail, he vowed to pull America out of the Trans-Pacific Partnership, brand China a currency manipulator and build a wall along the border with Mexico.
To be sure, it has not been all bad news for markets after Mr Trump's surprise victory. The Dow Jones Industrial Average climbed to a record last Friday, while China's Shanghai Composite Index entered a bull market. Russian equities also rallied on speculation Mr Trump will improve ties with Moscow.
Still, strategists from JPMorgan Chase to Citigroup and Societe Generale have warned that uncertainty about the path of US trade policy has the potential to trigger further emerging-market declines.
JPMorgan has cut its recommendation on dollar-denominated bonds to "underweight" and added short positions in currencies, including the Malaysian ringgit.
"Definitely the steepening of the US yield curve is one cause for the emerging-market sell-off," said head of Asian fixed income Rajeev De Mello at Schroder Investment Management in Singapore.
"I'd say it's way too early to think the correction is done."