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. Last Updated: 07/27/2016

Emerging Markets Slow-Up

LONDON -- The flow of investment into emerging markets may slow if U.S. interest rates rise, analysts said last week.

The release last Friday of higher-than-expected U.S. employment figures for June stoked fears the Federal Reserve -- the U.S. central bank -- will raise interest rates in August.

"There is a fear a rate hike would dampen enthusiasm [for emerging markets]," said Joe MacHatton, Latin American strategist for Kleinwort Benson Securities. "The level of worry in equity markets would increase in general."

"Clearly the rise in interest rates translates into a weaker U.S. stock market," said Michael Sonnenshine, a senior analyst at ING Barings. "This means some people want to take profits off the table."

Stronger U.S. interest rates could also lead American investors to eschew risks overseas in favor of fixed-income investments at home, Sonnenshine said.

"If U.S. bonds are more attractive to U.S. investors, the pool of money available for foreign investment becomes smaller," MacHatton said.

Out of the estimated $6 trillion invested in the emerging markets, $1 trillion might be diverted out of them if U.S. rates rise, he said.

The key is how much interest rates rise.

If the yield on U.S. longbonds rose from its present level of 7.25 percent to 7.5 percent, sentiment would begin to turn away from the emerging markets, while a rise to 7.75 percent or 8 percent would definitely be a problem, MacHatton said.

"That would be a depressant on the U.S. equity market and result in Americans feeling less wealthy and pulling in their money a little more," MacHatton said.

But not all analysts are convinced that a rate hike would dampen enthusiasm.

"We've had this expectation that U.S. rates would rise for some time," said Nigel Rendell, a strategist with James Capel.

"It's been a theme throughout the first half of the year and, if you look at what's happening in emerging markets in the first half of this year, it's pretty spectacular."

In dollar terms, investments in Hungary have doubled since Jan. 1, and all of the top 10 emerging markets have generated capital gains of more than 20 percent, Rendell said.

"If and when it takes place, the [U.S. rate] increase would probably be no more than 50 basis points," which emerging markets could weather, Rendell said.

Nor should emerging markets be viewed as a single block. "We have to distinguish what kind of money we're talking about," Sonnenshine said.

Investors risking funds in emerging markets for a 20 percent return are unlikely to be swayed by an increase in the longbond yield to 7 percent from 6 percent, Sonnenshine said. However, those invested in issues offering a 10 percent return could be more easily lured back to the United States.

"It's hard to say how much money goes into emerging markets in search of higher yield and how much goes in because the returns are so attractive," Sonnenshine said.

The varying returns of different emerging markets would also determine how many investments would be affected by a rate hike.

"Money flowing into Russia is looking for astronomical returns, while money flowing into Latin America is looking for good returns," Sonnenshine said.

Russia has been attracting investors with returns of 40, 50, 60 and even 70 percent.

Rendell called U.S. events largely irrelevant to many markets, particularly Eastern Europe.