LONDON, June 4 (Reuters) - Emerging market bulls who had reckoned on a boost from euro zone policy easing are instead facing an incipient rise in U.S. bond yields that threatens to wipe out any support from the ECB.
The European Central Bank is expected to drive one of its main interest rates into negative territory and boost liquidity on Thursday as it grapples with the threat of deflation and a stubborn economic funk in the euro zone. If that doesn't work, it may even pump in billions of euros via bond-buying, an option almost unthinkable a year ago.
In theory that is a potent tailwind for emerging markets and should add to gains they have enjoyed from this year's unexpected rally in U.S. Treasuries.
But a 15 basis point jump in 10-year U.S. bond yields this week suggests any ECB action may be overshadowed by changing U.S. interest rate expectations as the world's biggest economy strengthens.
"U.S. rates ... are always a critical issue for emerging markets, a far more important driver than what the ECB does. We have a view that U.S. yields have to move higher," says Philip Poole, head of global research at Deutsche Asset Management.
"We see the U.S. recovery becoming more self-sustained and yields becoming more normalised."
A big test looms on Friday in data that analysts predict will show a healthy 218,000 U.S. jobs added last month.
While U.S. interest rates will not rise before mid-2015, the Federal Reserve's monthly bond purchases will be down to just $15 billion by October and may even end then. At least one Fed banker has called for a rate hike soon after bond-buying ends.
The prospect of ECB action has already had some impact on emerging markets. Euro bond sales have exploded, with borrowers as diverse as South Korea, Brazilian bank BBVA, Russia's Alfa Bank and Indian telecoms firm Bharti rushing to borrow in euros.
Polish and Hungarian bond yields have also been driven to multi-month or even record lows, with demand levels at last week's auction of forint bonds among the highest on record and interest rates in the region seen following the ECB lower.
And more cash is expected to flow into emerging markets from the euro zone periphery as yields there fall further.
"ECB easing will probably encourage European investors to look across to emerging markets," said Greg Saichin, head of emerging debt at Allianz Global Investors.
"I have anecdotal evidence of Italian and Spanish clients sniffing at emerging debt ... As Europe recovers it is squeezing returns more, and investments in the front end of bond curves are not palatable any more for anyone who needs yield."
For some, though, there's a sense of deja vu about all this.
In early 2013, Japan's plans to print trillions of yen were supposed to unleash a rip-roaring rally across emerging markets, with small retail investors - characterised as Mrs Watanabe - expected to arrive with bagfuls of cheap yen to invest.
Instead, ex-Fed boss Ben Bernanke made a speech in May 2013 that sent developing economies into a six-month long tailspin as his hints about the end of bond buying fuelled a massive surge in U.S. Treasury yields.
"Anyone feeling reminded of spring 2013, replacing the BoJ with the ECB?," asks David Hauner, head of EEMEA fixed income and economics at Bank of America Merrill Lynch. "A lot, or too much, is riding on the ECB."
He predicts first of all that the ECB will deliver less than the market expects. Indeed, traders polled by Reuters expect very little long-trm impact on European money markets, the euro or bond yields if the ECB cuts rates from an already record low 0.5 percent.
True, the ECB may eventually resort to the radical option of quantitative easing (QE) or money-printing and could end up buying a trillion euros worth of assets.
But even that would be modest compared to the Fed, which has increased the assets on its balance sheet by $4 trillion since 2008. The BOJ too has increased its purchases of government bonds to $2.4 trillion from $1.6 trillion a year ago.
Nor is an invasion of emerging markets anticipated from Mrs Watanabe's yield-hunting German cousin. Deutsche's Poole, for instance, still favours bonds from Spain or Italy over Hungary or Poland, despite their rock-bottom yields, noting a fundamental improvement story in these economies, which were once at the forefront of the euro zone's debt crisis.
UBS analysts said that while it was tempting to speculate on huge QE-induced outflows from Europe, that outcome was unlikely.
"The experience from Japan post-BoJ easing certainly doesn't inspire confidence in this regard," they added.
And while negative euro zone rates would provide an impetus for European investors to take their cash elsewhere, U.S.-domiciled funds still dominate the emerging market investment world. For them, U.S. yields matter above everything else.
Already this week, as the dollar has flexed its muscles, currencies from the Brazilian real to the Indonesian rupiah have fallen 1-2 percent versus the greenback while yields on domestic emerging debt have jumped to two-week highs on the GBI-EM index.
"Most emerging currencies have a far closer relationship with the dollar than with the euro," said Julian Mayo, a fund manager at Charlemagne Asset Management.
"What happens in Washington DC is much more important than what happens in Frankfurt."
(Editing by Catherine Evans)