Market Report: US rate rise is bad news for Europe, ABN warns

The party could soon be over for all those hedge funds who have been busy taking advantage of the low interest rates in the US to borrow money to buy European stocks, ABN Amro warned. The squeeze on such investors started yesterday after the US Federal Reserve announced a rise in rates, and this definitely spells bad news for European shares, according to the Dutch broker.

The party could soon be over for all those hedge funds who have been busy taking advantage of the low interest rates in the US to borrow money to buy European stocks, ABN Amro warned. The squeeze on such investors started yesterday after the US Federal Reserve announced a rise in rates, and this definitely spells bad news for European shares, according to the Dutch broker.

ABN turned cautious yesterday on European equities and suggested a sharp sell-off is possible in the coming days given the "shaky platform of dollar debt that many trading positions in the European market have been built on". The practice of using relatively cheap short-term dollar loans to fund investment in stocks on this side of the Atlantic is known as a "global risk carry trade".

Rolf Elgeti, a strategist at the Dutch broker, believes many investors, particularly hedge funds, have employed such a tactic to enlarge their positions and boost their returns. But this leaves them very exposed to rises in US interest rates, which could total three-quarters of a per cent by the summer, according to the ABN Amro analyst. He believes the rise in rates could cause many investors to sell their positions in Europe to meet increased loan costs, which will put significant downward pressure on stock prices.

And Mr Elgeti is convinced the latest market data backs up his stance. He said: "Cracks in the global risk carry trade are starting to appear, with data showing investors are starting to get nervous." Hence it was no surprise that the FTSE 100 managed only a 3-point rise to 4,937 yesterday while the FTSE 250 was heavily sold-off, losing 28 points to 7,200.

Elsewhere, bears of easyJet suffered a nasty mauling as shares in the no-frills airline jumped 14.5p to 212.75p after an in line trading statement. EasyJet had registered falls for six session on the trot prior to yesterday's jump as hedge funds took short positions in the stock, convinced that that airline was about to issue a profits warning. They took the view that the rising price of oil would have significantly added to costs at the airline. But EasyJet poured cold water on such suggestions. Ray Webster, its chief executive, said: "The price of fuel remains high and volatile. In spite of this, operating margins for the period are expected to be broadly in line with last year."

Despite their losses, hedge funds moved on to a new stock. Dealers reported that a number were piling into Somerfield, 5.75p higher to 197.75p, as they bet on a fresh bid for the food retailer in the near future. A month ago, Baugur, the Icelandic retailer, said it was reviewing its options after the Somerfield board rejected its 190p-a-share offer which would have valued the company at £1bn.

According to the latest market gossip, the new offer will be priced at 210p and will come from either Baugur or the entrepreneurs Robert and Vincent Tchenguiz. The brothers are said to have been attracted to the retailer by its extensive property portfolio. Not only does it underpin the value of Somerfield but it also makes it easier for any prospective buyer to secure debt financing for a deal. Richard Ratner, a retail sector analysts at Seymour Pierce, suggested a joint bid by Baugur and the Tchenguiz brothers is also a possibility.

Given the recent negative news from electrical retailers few were surprised to see Kesa Electricals fall 2.5p to 309p before its full-year results today. Analysts expect it to unveil a rise of about 8 per cent in pre-tax profits to £194m. Marshalls, off 3.5p to 308p, saw three directors buy a total of 24,000 shares. Leading way was Mike Davis, the chairman of the building materials group, who picked up 20,000.

At the small-cap end of the market, DA Group added 4.5p to 105.5p on talk that a number of institutional investors were eager to buy into the company. Among them was said to be Fidelity Investments. API dropped 14p to 164p on worries that takeover talks at the packing group may have hit a snag. Shore Capital held steady at 41.25p despite news that Howard Shore, the chairman of the stockbrokerage, had sold 15 million shares at 40p, netting him £6m.

Mears fell 4.5p to 242p on profit-taking after forecast-busting results from the support services group. Mears boasted of a 42 per cent jump in profits for the year just gone to £7.4m and said that its order book now stands at £815m.

Finally, investors were keenly awaiting today's float from IBS Opensystems on AIM. The company, which provides software for managing social housing, has raised £56m at 140p and brokers expect the stock to enjoy a strong maiden session.