With the announcement of the CPI rising again in May 2022, the Fed was put under even more pressure as the previous hikes did not show the desired effect. This led to the announcement of the Fed increasing the federal fund rate by 75 basis points instead of 50 which was the prediction ahead of the bad CPI news. In addition, the Fed announced a hike of either 50 or 75 basis points in July to combat inflation. The expectation of the federal fund rate for the end of 2022 is now between 3% and 4% and even higher for the end of 2023. Historically, inflation and interest rates have rarely been so far apart as Figure 1 shows. For example, in the 1980s when the inflation reached 20% for a short time, the federal fund rate was between 10% and 15%. These announcements led to another decline in bond and equity markets. The Fed’s plan to decrease their balance sheet further pressures these markets. In particular, as the decrease just started in June 2022, and is expected to more than double by September 2022. In the European Union, inflation hits a record 8.6% and the central bank is preparing its first interest rate hike. Commodity markets are not doing great either. After their rally in early 2022, largely backed by inflation and war concerns, commodities declined during June 2022, albeit to a relatively low degree. Cryptocurrencies are feeling the pain the most, as Bitcoin dropped below the infamous $20k mark, while Ethereum fell below the $1k mark last week. These was a short-lived recovery which was stopped again by the discussions on regulation of cryptocurrency exchanges in the European Union. Alongside the collapse of TerraUSD (LUNA) last month, the collapse of DeFi platform Celsius and crypto hedge fund Three Arrows did not increase the confidence in the space. Given that the macroeconomic outlook is not favourable, it is unlikely that this decline will revert quickly. It is much more likely to continue for some time. While the decline in crypto asset seems dramatic, it is quite common for the asset class. This is further shown by Figure 2 which compares the drawdowns of asset classes in terms of standard deviations. It shows that the decline in Bitcoin is equivalent to the drop in equities, which are both far less than what bonds experience currently. In particular the 2-year yield has experienced a huge 5.68 standard deviation move. Although Bitcoin is considered the safest crypto investment, a few altcoins managed to outperform BTC during this recent drawdown. Figure 3 shows a comparison of the most important cryptocurrencies and their performance with BTC as a benchmark. In the hedge fund space, conventional bond and equity strategies continue to struggle. More defensive strategies, such as fund of funds, as well as niche strategies that focus on bear markets mitigate the current drawdowns or may even profit from it for the aforementioned niche strategies. The big profiteers of this ecosystem are global macro and commodity funds that have returned huge numbers so far in 2022. The best example for this is the Discretionary Global Macro strategy with a YTD of 158%.
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