The prospect of ever looser U.S. monetary policy is little consolation for emerging-market investors grappling with a resurgent dollar.

Rather than weaken, the world’s reserve currency has strengthened against all but one major emerging-market peers since the Federal Reserve cut interest rates in July. Earlier this month, the trade-weighted dollar index touched an all-time high, pushing past a peak seen in 2002.

Meanwhile, speculation that China may be using the yuan as a tool in the trade spat with the U.S. is bolstering havens, a sign that the worst for emerging-markets probably isn’t over.

The dollar’s ascent undermines the modus operandi for investors in the developing world. Borrowing where rates are low to invest in higher-yielding emerging-market assets is futile if the dollar’s strength wipes out gains. And it creates headwinds for large swaths of debtors in the developing world, where companies and governments rely on foreign funding for growth.

“My big concern is about the dollar. At the moment, when people want certainty, when they want a safe haven they tend to go to the dollar,” said Paul McNamara, a London-based fund manager who helps oversee $9.4 billion in assets at GAM UK, in Bloomberg TV interview on Tuesday. “That tends to be a tough environment for emerging markets.”

Traders who went long local-currency government debt in the developing world after the Federal Reserve’s decision at the end of last month will have have suffered a more than 2% loss, according to a Bloomberg Barclays index, even as global bond markets rallied.

Dollar Demand

The market has now fully priced another 25 basis-point cut by the Fed in September, yet the dollar’s unwavering strength reflects the special status America enjoys at times of heightened global unease: it issues U.S. Treasuries, the biggest and most liquid market for safe government debt.

“It’s hard to argue against the dollar in the short term,” said Chris Turner, the head of foreign-exchange strategy at ING in London. “With so many event risks, such as trade escalation and European politics, we suspect investors will increasingly focus on capital preservation rather than the search for yield.”

The Bloomberg Dollar Spot Index has gained 2.1% this year, compared with a loss of 1.6% for the MSCI Emerging Markets Currency Index.

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