Although there is a recession looming, markets started well in the fourth quarter. In particular, equities were able to recover some of their losses during the year. This development largely stems from the better-than-expected inflation report in the US. The inflation dropped to 7.75% compared to more than 8% for the past couple of months. The strong stance on interest rate hikes by the Fed seems to show an impact finally. However, this development needs to continue until inflation is back under control. While this development is a good indicator, the threat of a recession is far from over. For example, the yield curve does not look healthy at all, which has been the case for a while now. Figure 1 shows the current yield curve inversion in percentage relative to the inflationary bust in 1973/74. It suggests a strong possibility of a recession, as there always was a recession if the current threshold was surpassed. Nonetheless, with the inflation “cooling”, there might be a chance to avoid such a recession. The largest shock occurred in the cryptocurrency market. With the bankruptcy of FTX, one of the largest centralized exchanges, the industry took a huge hit. Just a few months ago, the company was in talks of raising another $1bn at a valuation of $32bn. The company collapsed after a liquidity shock. Documents in the bankruptcy filing reveal that the company had less than $1bn in assets compared to more than $9bn in liabilities. Initially, it seemed as if Binance, the largest centralized cryptocurrency exchange, might buy FTX. However, Binance decided against this endeavor. Following these events, the cryptocurrency market took a substantial hit. Bitcoin dropped to below $16k, and Ethereum fell lower than $1.2k. Since then, the market has remained relatively stable close to its lows. Figure 2 shows the price development of Bitcoin over the past three months. Nonetheless, the crypto market remains of interest. There is substantial interest from institutional investors, and the new lows offer good entry points for VCs, especially as they are under pressure to deploy capital. In the recent past, VCs have committed substantial amounts to crypto startups and emerging companies. Among these emerging technologies, the metaverse has the potential to become a significant industry. McKinsey estimated that the metaverse could be valued at up to $5tn by 2030, as shown in Figure 3. They see high potential in e-commerce, banking, telecom, and retail, among other industries.

​The UK’s economy continues to be under high pressure. While high inflation affects all countries, Truss’s historical tax cut and its outlined budget sent markets crashing. In particular government bonds alongside the British Pound experienced an alarming development, such that the BoE had to intervene and stabilize the economy. This had a brief stabilization effect, as the support was for a limited amount of time, as shown in Figure 1. This short support is largely due to the fact that it goes against the plan of central banks globally which try to reduce their balance sheets following the substantial interventions during Covid-19. This financial emergency led to Truss’s resignation from her position as prime minister. Her initial rival Sunak took over the office soon after and faces a tough situation ahead. Following this turmoil, markets have somewhat calmed down with Sunak’s appointment as PM and his experience in former financial positions. Meanwhile, other countries are still committed to raising interest rates. For the Fed, it is widely expected that rates will be raised by another 75bps in early November reaching 4%. With this following hike, officials say that further hikes are to be expected, although the magnitude might slow down. Further hikes are increasingly likely as the inflation rate is not really cooling down, and remains at 8.2%, down from 8.3% in the prior month. The relatively stable decline in equities is also unlikely to stop any time soon. Not only is there a constantly looming threat of a recession, but the equity market also tends to be correlated to central bank assets, as shown in Figure 2. This relationship is intuitive, as more assets or capital in the market are deployed. Furthermore, during Covid-19, much of the injected capital flew directly into stocks. With the back scaling of available capital, it is withdrawn from more risky capital, which is frequently stemming from equities. Although cryptocurrencies took a huge hit in early 2022, since July 2022, their performance is positive unlike bonds, stocks, or gold. This is a relieving sign for the industry, as cryptocurrencies tend to be strongly correlated with other asset classes at the beginning of a drawdown, but is the first asset class to recover from it. In this state, the asset class usually regains its attractive property of being non-correlated to other asset classes. Another highly intriguing development is taking place with Web3 applications. Web3 applications essentially fulfill the same role as technology companies leveraging the internet. However, unlike these technology companies, Web3 platforms are built decentral and are not maintained by a single entity. The current state of the Web3 industry strongly resembles these technology companies during the dot-com bubble. Figure 4 highlights a few key similarities. Venture investing in these types of companies also has not taken a large hit, compared to most other asset classes. This is in particular notable, as traditional venture investing took a substantial hit in 2022. Figure 5 shows the consistent decline in venture investments since Q4 2021.

Macro news still continues to drive markets. Europe is at the center in early September. At the end of August, Europe’s inflation soared to another record this year at 9.1%. This increase is largely due to ever-soaring energy and food prices. A week after the release of inflation data, the ECB raised interest rates by 75bps which raises its base interest rate to 1.25%, still far off from other countries, such as the US or the UK. A recession in Europe is getting more and more likely with such announcements. This threat is especially high for the UK, as Goldman Sachs expects the recession to start in the UK in the fourth quarter. The UK faces the same issues as Europe does, but at an elevated pace. UK’s inflation is higher than 10% while the BoE has raised interest rates significantly more this year already. While the current base rate is only marginally higher at 1.75%, another decision in early September was delayed following the passing of the Queen last week. The weak currencies are another issue. Both, the Euro and the British Pound, are exceptionally weak compared to the US Dollar historically. In the US, the situation seems a bit more stable. Last month, the US managed to re-employ all people fired during Covid-19, and the country continues to employ more people, leading to a record low unemployment rate. However, markets are still heavily pressured by the hawkish Fed. The board emphasized that they are strongly committed to bringing inflation down soon rather than later. Markets widely expect at least another 50bps if not a 75bps hike in the next meeting. Another major development takes place in the cryptocurrency market. “The merge” of Ethereum (ETH) will be executed around the 15th September 2022. Essentially, the merge refers to the combination of the ETH main-chain and its side-chain, known as Beacon chain (launched in December 2020). The main-chain is based on the PoW (Proof-of-Work) consensus algorithm, whereas the Beacon chain uses PoS (Proof-of-Stake). The difference between the two validation algorithms is the resulting energy cost. PoW uses computational power to validate the network. In this approach, all computers try to validate a transaction, in which the fastest is rewarded. Unsurprisingly, this leads to a lot of unnecessary energy consumption. PoS also uses computational power to validate transactions but it bundles the computers together and everyone gets a fraction of the reward. This prevents energy consumption for nothing and leads to an energy consumption decrease of more than 99.9%. Figure 3 summarizes the timeline of the merge. While it is unlikely that there will be a large move in ETH immediately after it takes place (assuming it works well), such events have historically been followed by strong performances of the underlying chains. One example is the introduction of the Beacon chain in December 2020, after which ETH rose from $400 to almost $4,000 in less than six months. Cryptocurrencies were relatively stable and gained slightly over the past weeks. Bitcoin is currently trading at $22k and ETH is valued at $1,750.  

​Alternative Markets Outlook H2 2022
Inflation will likely dominate the news in the latter half of 2022. It is likely to stay high although decreasing. Exact predictions are always difficult, especially in such a market environment. This is also observable in the research from economists who struggle to predict accurately, as employment is high, GDP is shrinking, and the current inflation issues. Whether inflation will in fact slow down is largely dependent on the ongoing war between Russia and the Ukraine, as energy and food are the main drivers behind the current inflation levels. Regardless of how the war ends, even if soon, there is a low chance that the energy supply of Russia to Europe will ramp up significantly. There may be some help from the OPEC+ countries in alleviating the problem but high energy prices are obviously beneficial for them. Food inflation on the other hand is likely to go down to some degree, as the Ukraine is a key supplier assuming that it remains independent. The energy situation will get very tense during the winter, as Europe is expecting energy shortages. It is likely that energy inflation will spike there. Afterward, in early and mid-2023, the situation likely will improve. At that point, energy prices have a chance to enter a deflationary state, as inflation is measured on a year-on-year basis, in particular when considering that energy inflation is higher than 40% in the US for example. The remaining subcategories in inflation measures are more affected by actual central bank measures. In particular, the US and the UK have taken substantial measures to combat current inflation. At least in the US, the measures have relieved some of the pressure as the monthly inflation fell for the time in a couple of months. However, this does not ease the pressure, as such events must be persistent. It is likely that this will continue, especially if the Fed keeps rising its interest rates, which some of the board members intend to do. It is expected that inflation will keep going down during 2022 and 2023. Frequently expected intervals estimate inflation to be between 2% and 4% towards the end of this period. Figure 1 shows expectations for the core CPI in the year 2023 alongside a lagged M2 growth measure. In Europe, the situation in terms of food and energy is more dire, due to its direct reliance on Russia. However, energy inflation surprisingly is lower than in the US but is rapidly growing, especially with the current concerns about the winter ahead. In terms of central bank measures, it becomes a bit more tricky, as the ECB has to manage many countries and consider their economic situation. This is where its major problem occurs, as large countries, such as Italy, are in a dangerous position. Its debt level is extremely high and it is potentially at risk of defaulting if interest rates should rise. On the other hand, the ECB has to combat the ever-soaring inflation by rising the interest rates. This dilemma will likely reduce the ECB's capabilities to combat inflation by rising interest rates as the UK or the US did. Most likely, this will cause inflation to be mitigated slower and to a lower degree. It is therefore expected that inflation in Europe will still rise in the latter half of 2022 and decline slower than in the US or the UK. This assumption is based on a status quo-like ongoing war. Nonetheless, sudden events can massively alter this outcome. Contrary to the outlook of Europe, the US’s development in July 2022 is largely positive. Firstly, it managed to reduce inflation slightly for the first time in multiple months. Secondly, US employment is back at pre-Covid levels and at the highest since 1969. While the economy lost 22 million jobs in the first two months of the Covid outbreak, in July 2022, it regained all of them. The impressive recovery is shown in Figure 2.

 Alternative Markets Summary H1 2022
Ever since Covid-19 has subsided from the daily news, inflation has taken over. Inflation is still a major concern in the current economy. This is further exacerbated by central bank interventions that have not been fruitful yet. An additional major contributor is the ongoing war between Russia and Ukraine. As of June 2022, inflation in the US is at 9.1%, the highest it has been in the past 40 years. In the Eurozone, inflation is slightly lower at 8.6%. The UK’s inflation is even higher at 9.4%. Asian countries, such as Japan and China, managed to keep their inflation relatively low at 2.4% and 2.5%. The development of inflation over the past year is summarized in Figure 1. For Western countries, inflation has more or less continuously risen. The US started the year with inflation close to over 5%, while European countries were close to 2%. Nonetheless, Europe has caught up to the US since April, when the UK’s inflation even got higher than the US’s. A potential reason for the higher inflation in the US at the beginning of the year and back until the latter half of 2021 is the rapid and steep unconventional measures taken by the Fed. This faster intervention led to more money being in the economy earlier, which theoretically should lead to higher inflation earlier. Figure 2 shows the growth in the balance sheet indexed to January 2019. Once Covid-19 hit the economy, the US reacted a lot faster and in higher magnitudes than Europe did. Within the first months, the Fed’s balance sheet grew by almost 70%, while the ECB’s only grew by 25% in the same time frame. Since then, the two central banks acted equivalently in terms of balance sheet growth. Very recently, the central banks started to shrink their balance sheets. These measures were announced during Q2 2022 and are slowly implemented. Going forward, this balance sheet shrinking will be strengthened, which is confirmed by an announcement from the ECB recently. Nonetheless, as the graph shows, these measures barely affect the original measures taken to combat the economic consequences of Covid-19. The low inflation in China largely stems from the consequences of their zero-Covid policy. In recent months, many places have been shut down to control the spread of Covid. This led to low production levels and low demand which is reflected in the low inflation levels of the country. In the case of Japan, inflation of above 2% is significant, as the average inflation during the past three decades was only 0.3%. Its inflation largely stems from the consequences of the war and the impact it has on food and energy.

Macroeconomic factors continue to dominate financial markets. Inflation in the US keeps rising, despite attempts of the Fed to slow it down. In June, inflation rose to 9.1%, higher than the anticipated 8.8%. Figure 1 summarizes the development of inflation over the past year in the US. The major drivers remain food and energy, but these are not the only issues. As the prior two are global issues, it is unlikely that those factors will slow down quickly. The Russia-Ukraine war has a substantial impact on those factors. Russia, a key supplier of energy, has led to the possibility of Europe not being able to use as much energy for heating in the winter as usual. Ukraine, which is a key supplier of food, e.g., wheat, puts further pressure on food prices. That Russia started burning down acres does not help the matter either. Although this has no direct impact on the US, the impact on the price of those goods is a significant contributor to the increased prices of those goods. This development has caused markets to anticipate an even larger hike in the upcoming July meeting. Markets analysts now see a hike of an entire percentage point as possible. This further emphasizes how dire the situation looks, as a few months ago, the discussions were between no hikes, a 25 bp, or at worst a 50bp hike. The US federal fund rate is now at 1.75% and likely to rise substantially. Despite these increases, inflation hit a record high (within the past four decades) in June 2022. With this in mind, voices of a looming recession are increasing. The fact that the yield curve inversion between 2y and 10y-Treasuries is at its highest since 2000, does not help mitigate this threat. Figure 2 shows the recent inversion of the two Treasury yields. This recession indicator should not be considered too much, as depending on which maturities are compared, the implications look very different. In Europe, the situation is even more serious. Not only is the continent directly affected by the war and its possibly horrendous outcomes, but it is also susceptible to possible bottlenecks for both energy (in particular gas) and food. Additionally, EU inflation hit a new record of 8.6% in June 2022 without any central bank interventions yet. The development of inflation in the EU is shown in Figure 3. ​