Inflation remains a major concern and continues to exert pressure on markets. At least inflation is declining in most economies. In the US, inflation is declining since July 2022 due to the most aggressive measures taken by the Fed in comparison to other economies. Inflation fell from over 9% to now below 5%. The EU’s inflation kept rising until September 2022 when it surpassed the 11% mark. The more hesitant central bank interventions and higher exposure to the war led to a substantially slower decrease. As of April 2023, inflation still remains slightly above 8%. Toward the end of 2022, the UK behaved similarly to the EU, but could not maintain this trend. As of March, inflation in the UK remained above 10%. The continued struggle of the UK – in comparison to the EU – is largely attributable to a combination of its higher food price inflation, high reliability on gas, and worker shortages as well as wage rises. The latest data revealed that the UK could substantially reduce its inflation in April to below 9%. China and Switzerland were able to keep their inflation below 4% throughout this period and have achieved decreasing inflation similar to the previously discussed economies, albeit for different reasons. Japan followed this development but saw a spike in inflation in April 2023, which stems from a surge in food prices. Figure 1 summarizes the inflation rate development from the beginning of 2022. Figure 2 shows the corresponding interest rate measures the various central banks undertook. The Fed took the most aggressive measures with the current range being between 5% and 5.25%. Market participants widely expected rate hikes to stop earlier in 2023, and it seems now that during the June meeting, there will be a break. However, officials stated that the fight against inflation is not over, and further hikes are still reasonably likely. This dampened the optimism of market participants, especially considering views at the beginning of the year with fewer increases and possible cuts as early as autumn. Such a development seems highly unlikely at this stage. The BoE followed the Fed’s development most closely. Unfortunately, it did not achieve the same results, as the substantial discrepancy in inflation data shows. The ECB took almost half a year longer to implement such measures. As of May 2023, central bank rates in the EU are still 1.25% lower than compared to the US. It is also reasonable to assume that the ECB will continue hiking to offset its currently substantially higher inflation. This can be attributed to the later reaction of the ECB in comparison to the Fed. Switzerland, which had fewer problems with inflation, required less severe interventions. In total, the SNB increased its core interest rate by 2.25% since May 2022. In contrast to other Western economies, its core interest rate sits at a moderate 1.5%. Asian countries, such as China and Japan have struggled little with inflation and needed no or only minor central bank interventions. Nonetheless, the countries still did not go through the aftermath of Covid unscathed.
Figure 1: Inflation Rate in Percentages in the US, UK, EU, Switzerland, Japan, and China from January 2022 to April 2023, Sources: Stone Mountain Capital Research, Board of Governors of the Federal Reserve System, Eurostat, Office for National Statistics (UK), Swiss Federal Statistics Office, Ministry of Internal Affairs & Communication (JP), National Bureau of Statistics of China, May 2023
Figure 2: Interest Rates by the Central Banks of the US, EU, UK, Switzerland, Japan, and China from January 2022 to May 2023, Source: Stone Mountain Capital Research, Federal Reserve, ECB, BoE, SNB, BoJ, PBoC, May 2023
Despite the recent bank crashes and the increased recession fears they caused, markets have stabilized and performed well in the latter half of March and the beginning of April. Over the past months, the S&P 500 gained almost 7% and holds its position above 4,100. Similar developments occurred for gold and oil prices, with gold being up nearly 7% too, and oil close to 8%. While the gains from the equity markets can be largely attributed to a sign of relief that the banking crisis did not amount to a full crisis and a real possibility of the rate hikes stopping. The strong performance of gold can be largely attributed to the same factors. Within the recent bull run, gold reclaimed the $2000 per ounce mark. While oil plummeted for most of the year, its increase is caused by OPEC+’s last meeting when they announced a sharp production cut.
The crypto industry has been quiet in 2023 thus far. Despite the banking crisis and recession fears, the industry has done. Bitcoin (BTC), the most important coin is almost 80% in 2023 as of the time of writing. While Ethereum (ETH) has been less successful, it is still up 60%. Solana (SOL), a cryptocurrency that has been heralded as Ethereum-killer in 2021 completely collapsed in 2022 when it turned out the chain has substantial security issues. To address these issues the coin has been shut down multiple times which made investors lose confidence in the chain. On 12th April 2023, ETH will implement its Shanghai upgrade which led cryptos rally. The Shanghai upgrade will allow validators and stakers to withdraw their assets from the Beacon chain (the original sub-chain which allowed for the proof-of-stake consensus algorithm), which has not been possible since 2020. In total, more than 16 million ETH were locked on the Beacon chain so far. Although it is another upgrade to the chain, many see this update as “price”-neutral. While it makes staking and validating more attractive now, a lot of capital was locked and will be free for the first time in more than two years. However, most people think that not much will be withdrawn, given the dominance of ETH in DeFi and the relatively high staking yield. Additionally, ETH was worth a lot more and people will want to chase similar highs. While most cryptos rallied ahead of the upgrade, ETH was outpaced by both BTC and SOL. BTC additionally surpassed the $30k mark for the first time in a year ahead of the upgrade. Figure 1 shows the YTD of the three coins mentioned above.
2022 was a year that tested the worldwide economy. The highest inflation in 40 years, unprecedented interest rate hikes, and the invasion of Russia into Ukraine were only some contributors to the hugely difficult year of 2022. In the US, inflation started soaring during 2021 and peaked in the summer of 2022 at 9.1%. Thanks to the central bank’s quick response, inflation has since continuously slowed down and is currently at 6.5%. Europe had significantly more issues handling the inflation crisis. The EU started the year at an inflation rate of slightly above 5.5% and it continued to soar until October 2022 when it reached its peak at 11.5%. The UK was similarly affected, despite the BoE being the fastest-acting central bank to raise interest rates. However, its inflation behaved like the EU’s and soared to its peak at 11.1% in October 2022. Both economies have not been able to reduce inflation below 10% so far. In contrast to the US, European countries were much more affected by the direct impact of the war between Russia and Ukraine. Soaring energy and food prices, for both of which Russia and Ukraine are crucial suppliers, were the main constituents causing the high inflation. Additionally, the ECB did not enjoy as much freedom as the Fed had when raising interest rates. This is in large part due to the high indebtedness of certain European countries that would have gone bankrupt if interest rates would have been raised as much as the US did. Other countries, such as Switzerland, Japan, and China stand out in this discussion, as those countries managed to keep their inflation relatively low. Switzerland managed to avoid such high inflation due to its strong currency, and a limited dependency on fossil fuels. Japan avoided high inflation through the continued quantitative easing by the BoJ. However, in contrast to the other countries, Japan’s inflation is still soaring and poses substantial issues to the country. China avoided high inflation through its rigorous Covid policies and its limited governmental support when Covid emerged. The source of this soaring inflation is a combination of the war but is largely based on unprecedented central bank intervention to save the economy during the early Covid days when large parts of the economy were completely unable to function. Figure 1 shows the inflation levels of the previously mentioned countries during 2022.
Inflation was a core issue in 2022 and remains to be one in 2023. In the US, inflation started to decline in the summer of 2022 and remains currently at a level of 7.1%. Contrarily, in Europe and the UK, inflation remains a huge issue and has barely declined from its peak in 2022. It remains at 11.1% for the EU and at 10.7% for the UK. The difference between the inflation can largely be attributed to two factors. Firstly, the Fed hikes interest rates more aggressively than its European counterparts. This led to a quicker response to inflation. Secondly, Europe is more directly affected by the war between Russia and Ukraine and is largely dependent on Russian oil and gas, which soared in price following the war. Contrarily to other European countries, Switzerland managed to keep inflation relatively low with a peak in late summer 2022 at 3.5% and 3% currently. Switzerland managed to avoid high inflation due to its strong currency and relatively low demand for fossil fuels, as most of its electricity stems from hydropower and nuclear power. In Asia, both Japan and China also experience limited inflation issues. Japan achieved this through its central bank which continuously intervenes with large-scale monetary easing. Despite the low inflation, Japan is still suffering, as wages remain stagnant unlike in other major economies where it helps offset the higher inflation to some degree. China does not face an inflation problem, due to their different handling of the Covid crisis. Unlike most economies, they did not provide large stimuli to the economy. Additionally, their zero-Covid policy substantially reduced household demands. Figure 1 shows a summary of the inflation rates across the highlighted economies during 2022. Regarding 2023, it is widely expected that inflation, especially in high-inflation countries, will come down. For instance, in the US, it is expected that inflation will be around 4% on average, and close to the 2% Fed target by the end of the year. Inflation forecasts in the EU and the UK are more difficult to estimate, due to their dependency on the war and its outcome. Additionally, unlike in the US, inflation has not really started to decrease. Assuming further strong interventions by the European central banks, it is expected that inflation will drop substantially. The ECB expects the average inflation to be around 5%-6% during 2023 with inflation slightly below 4% by the end of 2023. In the short term, Europe will be under pressure and the measures take time to become effective, as shown in the example of the US. Despite a similar outlook to the US, albeit with a delay of around half a year, it is less promising. One important wildcard is energy prices, which are strongly linked to the war. While the EU managed to get its oil largely from other sources than Russia, it still needs Russia, and gas is not as easily substitutable. With the prospect of Russia’s supply cut and China reopening, prices of energy sources are likely to increase. Depending on the scale, if it occurs, the anticipated target may not be reached and inflation will remain higher than the target. In Switzerland, inflation is expected to remain around the 3% mark for 2023. Given the strong involvement of the BoJ, Japan’s inflation is expected to end the year 2023 below the 2% inflation mark. It is additionally expected that wages will rise for the first time in three decades. Inflation in China is expected to rise to around 2% in 2023. This is a combination of the reopening of the economy and the end of the zero-Covid policy. This will lead to an increase in economic activity and the necessity for further energy. Additionally, the price pressure across will also be felt in China, once demand picks up again. The interest rate hikes by most countries have been another crucial topic during 2022. So far, the hikes have shown limited effectiveness in dealing with soaring inflation. In high-inflation countries, it was effective for the US and had little impact on the European countries. However, this discrepancy is likely due to the steeper hikes in the US and less dependency on the war by the US. The US employed the strongest measures, as it hiked from 0% at the beginning of 2022 to 4.25% at the end of 2022. In contrast, the ECB just started hiking in June 2022 at -0.5%, which increased to 2% by the end of 2022. The BoE employed a mixture of the two. The UK started hiking at the end of 2021 but hiked in smaller steps than the US. Towards the end of 2022, it increased the step size and is currently at 3.5%. Switzerland started hiking earlier than the ECB, despite substantially lower inflation. Switzerland’s prime rate became positive for the first time in years in September 2022. Currently, the prime rate is sitting at 1%. Japan was one of the exceptions, as the BoJ did not hike at all. Its prime rate remains at -0.1%. However, the central bank still strongly intervened in the market as elaborated previously. The People’s Bank of China even lowered its prime lending rate over 2022, albeit to a minimal degree. Currently, the rate is at 3.65%. There is a strong consensus for the year 2023 in the US and Japanese markets. Most market participants expect the Fed to keep raising interest rates to around 5%-5.25%. The Fed is likely to do this in smaller steps than previously. Nonetheless, this level should be reached by the end of Q1 2023. Afterward, a majority of institutions do not expect further hikes or cuts in 2023. The remainder anticipates potential interest rate cuts in Q4 2023. The exact outcome of potentially further hikes or cuts largely depends on the state of the US economy in the latter part of 2023. While the measures seem to be effective and inflation is going down considerably, the risk of a recession is considerable. This largely stems from substantially higher financing costs for businesses, and lower demand from consumers as Covid reserves are exhausted and households feel the pressure from the inflation over the past year. Given that the BoJ has not intervened by raising interest rates, it is not expected that it will in 2023. It is more likely that it will continue its qualitative and quantitative easing philosophy employed so far. In particular, as Japan does not face an imminent inflation problem. With expected wages adjusted, the pressure of inflation should also be eased without a strong necessity to make policy adjustments. For the EU, it is expected that rates will be hiked further to combat the prevalent inflation. Market participants expect interest rates of around 3%, which should be reached during Q2 2023. For the UK, additional hikes of 1% are expected, resulting in interest rates of around 4.5% for 2023. For both economies, no rate cuts are expected in the latter half of 2023. In Switzerland, the SNB is anticipated to hike another 0.5% in 2023 with no rate cuts as well.
With the final interest rate decisions of most central banks this year, it concludes a year of strong intervention to combat soaring inflation caused by the aftermath of Covid-19, and the ongoing war as well as general political instability. The Fed, the BoE, the ECB, and the SNB all increase their respective target rates by 50 basis points. The US interest rate is now at 4.25% - 4.5% with the British interest rate slightly lower at 3.5%. The European Union’s interest rate ends the year at a 2% target with the Swiss interest rate even lower at 1%. Figure 1 summarizes the interest rate hikes of these central banks during 2022. The UK and the US moved relatively quickly in increasing interest rates compared to the ECB and the Swiss National Bank. The impact of these measures is mixed at best. While inflation has been rampant throughout the year, only the Fed’s measures seem to have calmed inflation to a degree. The US inflation peaked in June at 9.1% and fell to 7.1% as of November 2022. Although they managed to control it, the degree to which inflation is reduced is far lower than the interest rate impact. Despite a similarly strong stance by the BoE, inflation is going up and down with a tendency to go up. The UK inflation remains at 10.7%. Compared to the US, the UK is dealing with several other issues not prominent in the US. Not only is the UK still somewhat in a transition phase with the EU, but it is also more directly impacted by the ongoing war and experienced a few chaotic months with the election, the resignation of ex-PM Truss, and her historical tax cut when the economy was already strongly under pressure. Inflation in the European Union is also unlikely to slow down fast given the close involvement in the war and the slow reaction to the rising inflation. As of October 2022, the EU’s inflation is the highest of the four economies at 11.5%. Lastly, Switzerland reacted slightly faster than the EU but hikes less aggressively. However, compared to the other economies, Switzerland does not face such an imminent problem with inflation, as the current inflation rate is only 3% with its previous peak being in August 2022 at only 3.5%. Figure 2 summarizes the development of inflation across the four discussed economies during 2022. Despite the general tone of central banks that they plan to decrease their balance sheet and keep raising interest rates well into 2023, market participants see fewer interest rate hikes ahead with a potential reversal earlier than expected. Going forward, interest rates will rise further with likely declining inflation, as the measures should work in the longer term. When inflation is showing signs of a continued slowdown and comes back to reasonable levels, interest rates are likely to decline gradually. This transition period will be especially intriguing to fixed income hedge funds and instruments, as high interest rates and low inflation offers stable and low-risk returns. This is especially true, as this economic ecosystem has not been present in the past decade. Equities did well in the latter half of 2022, despite the unfavorable ecosystem with rising interest rates and a harsh economy. If the situation should normalize sooner than expected, equities are well positioned to regain some of their incurred losses in the first half of 2022. Macro strategies have had an exceptional year in 2022 with plenty of opportunities. Most macro hedge funds could use these opportunities to generate strong returns.
Central Bank Interventions of the Fed, ECB, BoE, SNB Inflation in the US, the EU, the UK, and Switzerland
Voices of a recession in the coming year are getting louder. With the currently high inflation across the world, increasing interest rates, and drained reserves from the Covid-19 pandemic, companies are facing a bumpy road ahead. While inflation is declining to some degree, the crisis is far from over. In the US, inflation declined to 7.7%. This is likely a consequence of the continued and steep interest rate hikes from the Fed throughout the year that start paying off. With the most recent inflation data, the Fed hinted at lower hikes in the short term. In Europe, inflation is still higher, with 10% for the European Union and 9.6% for the UK. Nonetheless, it decreased in both instances compared to the previous month. Another interesting development is the price cap by the EU on Russian oil. It should mitigate Russia’s capabilities to finance the war with oil sales. Russia already stated that it will not oblige to the price cap. Over the past six months, oil substantially lost value. While it was trading well above $120 per barrel during the year, over the past six months it dropped. WTI crude oil is currently trading at $73 per barrel and has lost almost $10 per barrel since the official launch of the price cap on Russian oil. Figure 1 shows this development over the past six months. It will be interesting to monitor this development in terms of oil prices in general and whether the cap has the desired impact to stop Russian war financing. Since the end of Q3 2022, equities managed to rebound quite strongly and offset a proportion of the losses of the first three quarters this year. In contrast to the poor Q1-Q3 2022, the private equity industry was relatively stable over this time period, albeit with some losses and less activity. Nonetheless, the industry’s number of deals and deal value is still exceeding pre-pandemic levels, which is remarkable. Figure 2 provides further insights into global buyout deals, which make up most of the capital in the industry. Cryptocurrencies have not recovered from the shocking collapse of FTX. Since the collapse, Bitcoin is steadily moving between the $16k and $18k mark. Ethereum similarly moves between a range of $1.1k and $1.3k. Market participants are divided on their current opinions on the cryptocurrency market. With a looming recession ahead, cryptocurrencies are likely to face further drawdowns as highly risk-on assets. However, most people and institutions likely sold their over-allocation during the drawdown of 2022, and it remains to be seen how much more will be sold. Given the continued drawdown, most current holders are less likely to sell their positions due to being convicted of the underlying advances the technology will bring. Additionally, cryptocurrencies have done well in crises. Institutional investors also view the space with significantly different opinions. For example, Goldman Sachs plans to buy crypto on a large scale, while BlackRock is hesitant and expects many more collapses ahead.