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.
In this challenging ecosystem, alternative assets showed resilience to the drawdowns in public markets. While some hedge funds have struggled in recent times, the industry is managing the current situation well. For the first time since the pandemic, hedge fund launches have reached pre-pandemic levels again. Regarding performance, in particular large hedge funds have managed the drawdowns well. Figure 2 shows a comparison of public equities and bond indices relative to equity and fixed income hedge funds. For equity strategies, hedge funds were able to mitigate the largest drawdowns of public equities, while also benefitting from the recovery periods (although not to the degree as public equities have). For fixed income strategies, the results are even better. Not only were the funds able to mitigate the drawdowns in fixed income significantly, but they also posted stronger gains in the recovery periods, at least in most instances. Private debt and private equity funds achieved similar results, although it is unknown as of yet how they did in the very short-term. Throughout 2022, private debt funds managed to return a positive performance in each quarter and enhance the stability of a portfolio substantially. Private equity strategies functioned similarly to equity hedge funds, as they mitigated most of the drawdowns of public equity, even for the riskiest sub-strategy in venture capital. Figure 3 shows a comparison of direct lending, private equity, and venture capital benchmark indices versus public equities. While these results are promising, the private equity industry has not been unfazed by the recent crisis. Fundraising became a substantial issue in Q1 2023 as well as more and more downrounds. This leads private equity funds to search for alternatives. One of which seems to be buying back its own debt, which has been more prominent in recent months. Especially in the fundraising department, private debt also saw a substantial shortage, such that pension funds and endowments make up almost 50% of the capital raised. While higher interest rates also lead to higher yields in the private debt markets, it comes at an increased risk with rising loan default rates.
Although 2022 is over, the problems it brought with it are not. Inflation is still high, albeit not at peak levels of 2022. With this development, central banks are likely to stop hiking relatively soon, given that inflation keeps coming down. In the short-term, central banks will continue to hike with some of them reducing the size of the steps. The ECB raised its target rate in early February by another 50bps and announced they will continue to do so. While inflation in the US is better under control than in Europe, they also have their share of problems with a recession on the horizon. Rates are much higher with a lower (but historically still very high) inflation. The US is also facing the largest yield curve inversion since the 1980s, which is persisting for more than half a year by now. In this ecosystem, it is also not surprising that the US reached another peak in its trade deficit. While these developments are somewhat to be expected from the underlying economic situation, the labour market has been as a positive indicator for the entire 2022. In January 2023, the largest job cuts since 2020 was observed. However, this is largely stemming from huge job cuts of big tech stocks, which have suffered a contraction in 2022 after their bull run in 2021. The job cuts are also understandable given that many big tech firms have had their worst or close to their worst growth rate in their history. Similar things can be observed when looking at their revenues. Regarding the unemployment rate in general, it is still very low and there was consistent decline since the beginning of Covid-19. At least this indicator eases some of the pressure of the otherwise highly uncertain economy. In this ecosystem, market participants expect few further hikes with lower rates towards to the end of 2023 and thereafter. With the strong labour market in mind, it would be a great achievement for the Fed to combat inflation effectively without destroying the currently strong labour market. In this instance, it is realistic, as the cause of inflation were the policies applied during Covid-19, most notably the financial stimulus and essentially unlimited borrowing, led to inflow of available of money, which is in itself independent of the labour market. Figure 1 summarizes the expected development of the Fed fund rate until 2025. In the UK, the situation looks a bit more dire. While the BoE has hiked in similar frequencies, it could not combat inflation as effectively as the US. In addition, the UK is more directly affected by the war, which increases the overall pressure on markets. Despite, the BoE substantially adjusted their recession forecast, in which the GDP should only drop by 0.8% compared to almost 3% in their prior forecast. Figure 2 provides an overview of the new and old forecast of the BoE until 2025.
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.
|
|