I beat level 1 and picked up the instrument. When I dismiss the text, the instrument plays and I get the sound effect that shows when the screen would fade out, but nothing happens and the sound effect repeats while I'm stuck in the "holding the cello above my head" pose. If I exit to main menu and restart, I'm saved at the point where I beat the boss but haven't picked up the instrument yet. 

Has anyone else encountered this an know how to get around it?

Exact same issue for me, so far no joy getting past it.

Have you changed the default controls? I changed the mapping of WASD to other buttons I found more comfortable, and had the same issue of the game hanging when collecting the instrument. Exiting to main menu and going back in did nothing, closing the program and reopening it worked, so I assumed that was the trick. However, I had the same issue on the second instrument. I closed and reopened, remapped my controls again since the walk through the second dungeon is slightly longer than the first, and had it hang again despite the restart. I restarted again, walked there with default controls, and it didn't hang.