Inflation remains a major concern in 2022. It is also crucial to watch the central banks’ responses to deal with it. In particular, the inflation numbers in the coming months should be watched closely, as they likely determine the extent to which central banks intervene. As seen in May 2022, when the CPI was higher than expected, markets lost substantially. With current market expectation of US interest rates being close to 2% later this year, it is vital that the 50bps hike last month, as well as the upcoming hike (likely another 50bps) show effectiveness. If that should not hold, there will be a bumpy road ahead. Especially, as the Fed is starting to reduce its balance sheet, which puts further pressure on markets. A similar observation can be made for the UK. For the EU, this is likely occur a couple of months later, as they have not raised interest rates yet, but are expected to do very soon. This development, alongside the war and supply chain issues, has led to a more and more pessimistic view of GDP growth in most countries. The World Bank expects that most countries will in fact experience a recession. They further emphasize that stagflation is looming. The possibility of a stagflation environment is certainly not unlikely and many factors speak for it. For example, the very high inflation, frequently downward-adjusted GDP projections, and the pressure put on companies with significant supply chain problems among others. Although employment looks healthy in most countries, if this should worsen, the treat of stagflation becomes very urgent. A more detailed view on the macroeconomic situation is provided by Macro Eagle further below. Hedge funds are in a good position to mitigate much of this market volatility. Many hedge funds pursuing equity and fixed income strategies have experienced rough times but they have the capabilities to reduce risk in such a market environment, despite a rather unimpressive performance. Hedge funds that use different strategies than the previously mentioned ones, mostly had a great year. This is in particular true for global macro funds. A substantial number of funds managed to deliver a YTD in 2022 in excess of 100% already. Another strategy that stands out are funds of hedge funds that could truly show their risk mitigation potential. Although private equity and venture capital could not maintain their trend from 2021, the asset class still remains an attractive opportunity. Valuations are down since early 2022. However, the industry is still in a healthy state, despite the slump of public equities. Inflows in the industry are likely to be smaller than in 2021, but there is still significant investor interest as most investors report that their private equity investment substantially outperformed their public equity investments over the long-term. The industry also still sits on a large cash pile amassed over the past year that needs to be deployed. This pressure further mitigates the decline in valuations resulting from the bear market. ​

​Although financial markets are struggling in general, cryptocurrencies are suffering most. After the collapse of the Terra stablecoin in mid-May 2022, cryptocurrencies barely recovered their losses. Even before this crash, the market was down substantially. This development may indicate another ‘crypto winter’ as it was the case in late 2017 and early 2018. After this crash, Bitcoin needed until 2020 and other cryptocurrencies until 2021 to recover. Although the current ecosystem is certainly not favourable, the situation is not equivalent to 2017. There are numerous reasons for this. Firstly, the investor base has changed massively with many more institutional investors in the market. This is likely to reduce the volatility of the asset slightly, as the majority of capital in the market is still retail-based. Secondly, the principle of blockchain and the applications are a lot better understood than back in 2017 when most people held coins for the profit only. Nowadays, assets are also held out of conviction which should further limit the downside potential. Thirdly, cryptocurrencies tend to crash the hardest at the beginning of a crisis but also tend to recover ahead of other asset classes. One of the best examples of this occurred at the beginning of Covid-19 when Bitcoin recovered quickly and soon rose to a new record high. Currently, Bitcoin is trading relatively stable at the $30k mark. The development of Bitcoin during 2022 is shown in Figure 1. Ethereum is trading consistently trading below the $2k mark since the crash.

Financial markets are experiencing tremendous daily volatility amid an unprosperous outlook across the board. This is largely caused by the still increasing inflation, steep and continuous interest rates hikes and the ongoing war between the Ukraine and Russia. Outstanding bonds have substantially decreased in prices in 2022 so far and there is little hope that this is going to get better. For example, in the U.S., the Fed just recently started to increase interest rates to an interval between 0.75% and 1%. It is now widely expected that this interval will be increased by 0.5% in each of the following two meetings in June and July 2022. However, it is also being debated if the hikes could even reach 0.75%, if the inflation outlook should worsen. The latest inflation update did not help matters either, as the expected inflation was lower than the actual value. At the moment, U.S. inflation is at 8.3%, just slightly below the March’s numbers of 8.5%. When looking at the inflation level across the world, it is still increasing in most countries. Although inflation is low in China, it increased substantially from 1.5% to 2.1% in April. In the Euro area, inflation has now reached a level of 7.5%. The ECB told earlier in the year that interest rate hikes are unlikely to occur before the latter part of H2 2022. Currently, there are strong signals that ECB will begin raising its interest rates in July. This grim outlook has led to substantial sell-off of treasuries. Meanwhile, the 10-year U.S. Treasury has surpassed the 3% mark in early May. Aside from rising interest rates, central banks are planning to shrink their balance sheet, which will put further pressure on equities and the market in general. Equities have further suffered in May, even after one of the worst months in April 2022. In particular, technology stocks have substantially decreased, as they have been inflated the most since the central bank interventions following Covid-19. The Nasdaq Composite Index is down already 25% since the beginning of 2022. Figure 1 shows a comparison of the current tech valuation compared to their historical average. ​

​Markets are continuing to struggle in 2022. Equity markets have suffered substantial losses after their stellar 2021 caused by a combination of inflation, (expected) interest rate hikes and the Russia-Ukraine war. After the strong selloff at the end of April 2022 which closed the worst monthly performance since the financial crisis, equity indices are down substantially. The S&P500 is down almost 14% YTD while the tech-driven Nasdaq index is down more than 21%. The development of the S&P500 since January 2021 is shown in Figure 1 below. After its record high from the end of 2021, the index is as low as one year ago. Although equities are still high from a historical perspective, the anticipated, and very likely, interest rate hikes from the Fed are on the horizon. It is anticipated that the Fed will increase rates by 0.5% in May and possibly another 0.5% in June. This has a substantial impact on still highly valued stocks which will put further pressure on equities. Central banks are feeling the consequences of their extensive interventions during Covid-19. It led to record inflation levels (at least of the last 40 years), and the imminent treat of recession if interest rates are increased. Nonetheless, if interest rates are not increased, inflation could spiral out of control, if it has not already. Given that inflation has reached 8.5% in the US and 7.4% in Europe, the necessity to intervene is obvious. These difficult times are another opportunity for hedge funds to prove their worth, as they have since Covid-19. Despite losses of the industry collectively during Q1 2022, the industry still sees continued inflows. The difficulties from the uncertainties at the current moment make hedge fund selection more important, as the gap between good and bad hedge funds widened. Given the current market situation, equity-neutral, global macro and commodity-based strategies achieved great results. In particular our Discretionary Global Macro strategy had a phenomenal month with a gain of more than 50% in March and a gain of almost 150% in Q1 2022. Our crypto- and equity strategies did well in March 2022 and could partially offset their loss from earlier in the year. Nonetheless, this is unlikely to continue in April, due to the selloff in both markets at the end of the month. Another great alternative to be partially shielded to current market volatility is private equity and venture capital. Although both markets benefitted greatly from the overheated public markets in the past two years, valuations have declined slightly. Regardless of the decline in valuations, there is still a huge interest in the space as money keeps flowing in and the deal activity is very high in the space. The large amount of capital in the space alongside the competition are also likely to prevent such large decreases as the public equity markets see currently. Both of these markets, hedge funds and private equity, are large drivers of alternative markets. According to research from Goldman Sachs and Preqin, the AuM will significantly increase, even in a suboptimal ecosystem. In a grey-sky scenario, they expect the industry to grow to $14tn in 2026, up from $10tn in 2021. In a more favourable blue-sky scenario, they expect the AuM to rise to $31tn in the same time frame. Figures 2 and 3 show their findings.

​While the war in the Ukraine is going on with little progress towards peace, market participants are waiting for further moves from central banks and their announced interest rate hikes to combat inflation. Over the past months, the war had a substantial impact on the currency market, as the Russian Rubel has strongly appreciated against the US-Dollar since the invasion of Russia in the Ukraine. USD-RUB has stabilized at around 80RUB per USD, the same as it has been ahead of the crisis. This is remarkable as it spiked to more than 130 RUB/USD due to the severe sanctions imposed onto Russia. Figure 1 shows the development of RUB-USD since the start of 2022. Despite the sanctions of Russia and its currency, Russia can still control its currency well. They create artificial demand of the Rubel through different measures. For example, foreigners invested in Russia cannot sell their Rubels, they require European countries to pay Russian gas in Rubels, and they require Russian exporters to be paid to 80% of their income in Rubels. These measures all help appreciating the currency against the depreciation pressure from the sanctions. The role of the USD in the FX remains very important, as 88% of the FX transaction involve the USD as one of the currency pairs. It is also crucial in reserves for central banks as it makes up 59% in all currency reserves. This high relevance seems excessive given that it is only responsible for 25% of the world’s GDP. Nonetheless, these are consequences of a currency that is widely regarded as the world currency. An overview of this is shown in Figure 2. This is in particular relevant as for the first time sovereign currency reserves have been confiscated. This may lead central banks to diversify their reserves, increasing the relevance of other major currencies, emerging currencies and real assets, in particular gold. Gold has rallied since the initial threats were looming on the invasion of the Ukraine. It spiked at $2,052 per barrel but did not manage to hold onto this level. As the initial volatility faded, gold fell and is remaining between $1,940 and $1,980 per barrel. Figure 3 shows a summary of this development. Oil experienced substantial volatility, largely due to the invasion of Russia and Russia being a key supplier of oil. Oil started gaining since December 2021, when WTI crude was $70 per barrel. Amid geopolitical tensions and then the looming threat of the invasion, it rose to around $90 per barrel and spiked to $105 immediately once Russia effectively invaded the Ukraine. Since then, WTI rallied between $95 and $120 and has almost fallen to its lowest level since the invasion at $94 per barrel for WTI. Figure 4 summarizes this development. A similar development was observed in Brent crude, as it fell below the $100 mark for the second time only since the start of the invasion. Unlike oil, natural gas has risen to a 15-year high of $6.534 per MMBtu (metric million British terminal units), which poses a huge concern for Europe, as they are highly dependent on Russia’s gas. If Russia would decide to stop gas deliveries to European countries, this would cause a huge recession, as gas-dependent industries likely have to shut down operations very quickly. This is the case, as there are a lot more alternatives for the import of oil than there is for gas.

​Aside from the continuous news about the ongoing war between Russia and the Ukraine, macro events are increasing after they have been halted when the war started. Central banks will increase the interest rates gradually over the year to combat the steadily rising inflation. After Powell announced at the beginning of the year that there will be many, but small, interest rate hikes in 2022, equity markets lost substantially. The first interest rate hike was expected early on but was postponed and again when the war started. Even though the war is ongoing, in mid-March 2022, the Fed announced the first 25bps hike. In a statement a week later, Powell showed a more aggressive stance to get inflation under control by outlining the plan of six further 25bps hikes in 2022, which will take place after each meeting. For May, he outlined that there is a high chance that the hike may even be 50bps. Figure 1 summarizes the expectations of the interest hikes in the coming year. These planned hikes pose a major treat for an inversion of the yield curve, as the spread between 2y and 10y notes dropped to only 13bps as of last week. On Monday, the 28th March 2022, the yield curve inverted as the yield on the 5-year notes rose above the yield of the 30-year note. In all prior Fed tightening cycles since 2000, the yield curve inverted. This is particularly relevant, as this was just the first of planned seven hikes this year and the decline in the spread between short- and long-term rates has rarely been that quick. As a sign of a recession, it remains to be seen whether this scenario unfolds against Powell’s view of a flourishing economy, due to increased interest rates. Figure 2 shows the previous yield curve inversions since 2000. Increased interest rates also increase the attractivity of bonds, as they will generate returns again. Since Covid-19 when interest rates were basically zero at all times, attractivity of bonds substantially decreased which led to soaring equity market as bonds were no longer viable alternatives. It also fuelled the commodity rally, as bonds did not provide an alternative to manage inflation concerns. This led to many commodities reaching all-time highs at some points since Covid-19 emerged. The interventions of central banks to mitigate the economic effects of Covid-19 have caused an extreme situation and most macro variables are at record levels, or at least at a record level of a long timespan, as shown in Figure 3. Inflation is the major concern for central banks in 2022, as, for example, inflation reached 7.9% in the US in February. Europe is not doing much better, especially given the context of steep increases months later than in the US. While the ECB is holding interest rates for at least until the latter half of 2022, the BoE has increased interest rates three times already in 2022. The latest hike came in mid-March 2022 and was the third consecutive meeting in which interest rates were raised by 25bps each which results in rates of 0.75%. This also makes the BoE the first central bank to set its interest rate to pre-Covid levels. Now, the tone in terms of a tightening policy has been reduced to balance the impact of inflation and the economy, especially because of the soaring gas and oil prices from the Russia-Ukraine conflict. Figure 4 shows a summary of the CPIs of the UK over the past year and emphasizes the steep increase in most measures. The BoE also adjusted its forecast upwards to an average inflation of 8% in Q2 2022.