Investors are searching for answers on when inflation will abate, amid fears of an impending recession. As prognosticators parse data and projections, Morgan Stanley’sMS
 Chief Investment Officer, Lisa Shalett, sees a hidden threat that could exacerbate the inflationary picture: a mostly unnoticed anomaly in the relationship between the dollar and commodity prices.

For much of the last half-century, the strength of the US dollar was inversely related to the average price of commodities. When the dollar went up, and got stronger, commodities prices like oil and precious metals went down and vice versa, a product of the sacrosanct designation of the US dollar as the reserve currency of the world that leads to most commodity purchases being done with the American currency.

The black swan events of Covid-19, and its resulting supply chain shocks, and the Russian invasion of Ukraine, have apparently thrown this balance out of whack and may portend bad news for inflation. When these two metrics once again become tethered, the result could be a falling dollar, otherwise known as persistent inflation, despite a drop in commodity prices such as oil.

“We may get to a point sometime over the next three to six months, where the dollar starts to weaken on a relative basis as the US economy slows, and as other economies and central banks start to tighten,” Shalett says. “It may be that we get into a scenario where even though the Fed may have some success squashing demand [for goods and services]we may not squash inflation.”

This decoupling of the dollar and commodities has only happened twice since 1966. In 1979, inflation surpassed 14% and gold prices soared to more than $850 an ounce from less than $50 a few years prior. In the 1980s Fed Chairman Paul Volcker, who was appointed by President Carter, raised interest rates, ruthlessly moving the Federal Funds rate has high as 20%, ushering in a recession that collapsed inflation as well as commodity prices while the dollar strengthened. In 2001, commodity prices took off but with China being admitted to the World Trade Organization and flooding the US market with low-cost goods, inflation was kept in check.

The current situation is a result of a preceding decade in which US assets have massively outperformed global assets, creating a demand for dollars as well as a defensive posture in many economies over the past few years causing other countries to overbuy US dollars.