(Bloomberg) -- Developing-world currencies sank as Federal Reserve Chair Jerome Powell signaled interest rates will likely stay high for longer, sending US yields surging and further souring the mood in global markets. 

The Brazilian real and Mexican peso were among the biggest decliners on Tuesday, dropping at least 1.8% versus the dollar each, with carry traders dumping positions amid spikes in volatility and a resurgent dollar. The rupiah sank more than 2%, forcing Bank Indonesia to step in to support it, while China’s unexpected move to weaken its daily reference rate for the yuan also added to the pressure. 

Read More: Massive Global Carry Trade Unwinding Hits the ‘Super Peso’

The MSCI emerging-market currency index closed at the lowest since November as risk-off sentiment sent US two-year yields to 5% for the first time in five months, while the dollar extended a rally into a fifth session. Powell said on Tuesday that it’s appropriate to give the Fed’s restrictive policy further time to work, signaling rate cuts will take longer than expected to materialize. Investors are also on edge about tensions in the Middle East after Iran’s weekend attack on Israel. 

Developing-nation currencies have benefited for their so-called carry appeal as policymakers hiked rates earlier than their US counterparts to tame inflation. Now, with easing cycles underway from Brazil to Poland and Chile, the difference in borrowing costs will shrink and weaken developing-world exchange rates, according to Win Thin, managing director and global head of markets strategy at Brown Brothers Harriman & Co.

“Emerging markets are front running the Fed’s cut, and that is very risky since weaker currencies will tend to boost local inflation,” he said. 

Read More: Dollar Bulldozes Its Way Through EM Currencies Aided by Yuan

Currencies from Brazil, Poland and Mexico, which have some the highest real rates in the world, were among the worst performers of the day. The Mexican peso erased its gains for the year, while Brazil’s real is trading at the weakest since March 2023, also weighed down by fiscal risks. Poland’s zloty sank to the lowest level this year against the dollar. 

“Everything goes well until volatility kicks in,” said Alejandro Cuadrado, head of foreign-exchange strategy at BBVA in New York.  

Traders are awaiting a string of Fed speakers in the coming days, including Cleveland President Loretta Mester and Governor Michelle Bowman. 

The benchmark index for emerging-market equities lost 2% to close at the lowest in two months as China data, while better than expected, showed the economic recovery may be already fizzling out. Growth in retail sales slumped in March and industrial output fell short of forecasts. Latin American stocks dropped the lowest since November. 

“A strong Chinese GDP may have not boosted appetite for Chinese stocks, but it sure boosts worries that rising Chinese growth will fuel global inflation and make major central banks think twice about their rate cutting plans,” Ipek Ozkardeskaya, a senior analyst at Swissquote Bank, wrote in a note.  

The risks for China’s economy increased further after the European Union unleashed a barrage of trade restrictions against the country. In addition to an investigation into Chinese subsidies for electric vehicles, the bloc is looking into whether Beijing provided illegal support for wind parks on the continent. It has also brought subsidy probes into solar and railway firms and will shortly launch an inquiry into China’s procurement of medical devices.

Risky Debt

Elsewhere, the yuan fell to the lowest level since November and sparked a selloff across Asia after the People’s Bank of China unexpectedly set a weaker daily reference rate for the managed currency. The Indonesian rupiah slumped 2%, one of the worst performers among developing peers despite central bank intervention. 

The Israeli shekel also slid on Tuesday, rattled by geopolitical tensions as top military officials said Israel has no choice but to respond to Iran’s weekend attack. 

Sri Lanka, meantime, led losses in the dollar bond market as its first round of restructuring talks with investors failed. Traders also dumped notes of Pakistan, Angola, Nigeria and Egypt — countries that have rallied in recent months amid a craze for risky debt, just as emerging market investors, policymakers and International Monetary Fund officials convene in Washington D.C. this week.

--With assistance from Selcuk Gokoluk and Carolina Wilson.

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