Market perspectives
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Vanguard Perspective
|
July 27, 2023
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Projected returns
United States
Europe
United Kingdom
China
Emerging Markets
The views below are those of the global economics and markets team of Vanguard Investment Strategy Group as of July 19, 2023.
Key highlights
Recent inflation and labor reports suggest some cooling in the economy ahead of the Fed’s July monetary policy announcement.
Wage growth remained strong as the demand for workers continues to outstrip labor supply.
We recently lowered our forecast for full-year economic growth in China to 5.5%–6.0%.
Looking for our midyear outlook, view it here .
Projected returns
Vanguard’s outlook for financial markets
Our 10-year annualized nominal return and volatility forecasts are shown below. They are based on the March 31, 2023, running of the Vanguard Capital Markets Model ® (VCMM). Equity returns reflect a 2-point range around the 50th percentile of the distribution of probable outcomes. Fixed income returns reflect a 1-point range around the 50th percentile. More extreme returns are possible.
Equities
Return projection
Median volatility
U.S. equities
4.1%–6.1%
17.0%
U.S. value
4.4%–6.4%
19.6%
U.S. growth
1.4%–3.4%
18.2%
U.S. large-cap
4.1%–6.1%
16.7%
U.S. small-cap
4.4%–6.4%
22.3%
U.S. real estate investment trusts
4.4%–6.4%
20.1%
Global equities ex-U.S. (unhedged)
6.4%–8.4%
18.2%
Global ex-U.S. developed markets equities (unhedged)
6.1%–8.1%
16.6%
Emerging markets equities (unhedged)
6.1%–8.1%
25.9%
Fixed income
Return projection
Median volatility
U.S. aggregate bonds
3.6%–4.6%
5.5%
U.S. Treasury bonds
3.3%–4.3%
5.7%
U.S. intermediate credit bonds
4.2%–5.2%
5.2%
U.S. high-yield corporate bonds
5.5%–6.5%
10.1%
U.S. Treasury Inflation-Protected Securities
2.7%–3.7%
5.0%
U.S. cash
3.0%–4.0%
1.4%
Global bonds ex-U.S. (hedged)
3.6%–4.6%
4.4%
Emerging markets sovereign bonds
5.6%–6.6%
10.9%
U.S. inflation
2.0%–3.0%
2.3%
Notes: These probabilistic return assumptions depend on current market conditions and, as such, may change over time.
Source: Vanguard Investment Strategy Group.
IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of March 31, 2023. Results from the model may vary with each use and over time. For more information, see the Notes section at the end of this article.
Region-by-region outlook
United States
United States
The most recent inflation and labor reports suggest some cooling in the economy ahead of a July 26 monetary policy announcement by the Federal Reserve.
The Consumer Price Index rose 3.0% on a year-over-year basis in June, down from 4% in May. Core prices, which exclude food and energy, were 4.8% higher, down from 5.3% the month before. However, the path to the Fed’s 2.0% inflation target is likely to be long and winding. We expect year-over-year core inflation to finish 2023 around 3.3%, and that it will not fall below 2.0% until 2025.
Employers added 209,000 jobs in June, the fewest since December 2020, when there were net job losses. But the unemployment rate fell to 3.6%, within the 3.4%–3.7% range that has prevailed since March 2022. Wage growth remained strong—average hourly earnings were up 4.4% year-over-year in June—as the demand for workers continues to outstrip labor supply. We believe that gives Fed policymakers impetus to raise their target for short-term interest rates by 25 basis points (0.25 percentage point) on July 26.
At its last monetary policy meeting, on June 14, the Federal Open Market Committee voted to pause its interest rate hiking cycle, holding its rate target to a range of 5.00%–5.25%. In its “dot plot,” an aggregation of Fed officials’ individual views, the Fed suggested its rate target would be 5.50%–5.75% by year-end. That’s 25 basis points above our 5.25%–5.50% forecast range.
The neutral rate of interest in the United States may be higher than many people think—including Federal Reserve policymakers. That is among the findings of new Vanguard research that suggests current monetary policy may be less restrictive than generally assumed. Demographics began to push the neutral rate higher before the COVID-19 pandemic, the research finds, and fiscal deficits have accelerated the rise since.
The dividing line between tight and loose monetary policy may be higher than policymakers think
Notes :Â The Laubach-Williams and Holston-Laubach-Williams estimates of the U.S. neutral rate of interest are derived from Federal Reserve Bank of New York models. The Vanguard estimate is based on 2023 research by Joseph H. Davis, Ryan Zalla, Joana Rocha, and Josh Hirt.
Sources :Â Vanguard and Federal Reserve Bank of New York model estimates of the neutral rate through 2022.
The neutral rate is the theoretical central bank interest rate target that would neither restrict nor fuel activity in an economy at full employment. Assessments of the neutral rate, also known as R-star, are essential to policy-setting.
Vanguard’s neutral-rate estimate is about half a percentage point higher than the estimate produced by the Laubach-Williams model, the Fed’s most frequently cited neutral rate source, named for its economist authors. We ran our higher neutral-rate assessment through the Fed’s macroeconomic model under a range of monetary policy rules. The results suggested that the median effective rate target would peak at 6.00% in 2023. The Fed’s current rate target is 5.00%–5.25%.
In the longer term, the median central bank target rate would need to settle at 3.5%, or a full percentage point higher than the median long-run outlook in the Fed’s most recent Summary of Economic Projections . These “higher for longer” findings support the idea put forth by Joe Davis, Vanguard’s global chief economist, in his January Wall Street Journal  commentary  (subscription required) suggesting that long-term investors stand to benefit from a new era of “sound money.”
Europe
Euro area
Weak recent data, especially from Germany, the euro area’s largest economy, suggest that a recession continued between April and June, marking a third consecutive quarterly contraction.
“Weakness in the euro area has been broad-based across manufacturing and services,” said Shaan Raithatha, a Vanguard senior economist. “That’s consistent with another mild quarterly contraction in GDP, which would extend the recession.”
We expect the peak impact of monetary policy tightening to take hold in the second half of 2023, with the labor market weakening in the European Central Bank’s (ECB’s) continuing quest to bring inflation to its 2% target. We continue to anticipate full-year economic growth of 0.5%, though risks are now skewed to the downside.
The pace of both headline and core inflation, which excludes energy, food, alcohol, and tobacco prices, stood at 5.5% on a year-over-year basis in June. We believe that still-too-high inflation will lead the ECB to raise its deposit facility rate by a further 25–50 basis points to a peak of 3.75%–4%, with no rate cuts until mid-2024.
United Kingdom
A day after government data showed an unexpected rise in core inflation, the Bank of England (BOE) on June 22 announced a 50-basis-point (0.5 percentage point) increase in the bank rate, to 5%. We recently raised our forecast for the BOE’s peak rate by 75 basis points to a range of 5.5%–5.75%, given the stronger-than-expected inflation data, a continued tight labor market, and accelerating wage growth. We maintain our view that the BOE will not lower its rate target until mid-2024 at the earliest.
“The U.K. has had the worst of both worlds when it comes to inflation,” said Shaan Raithatha, a Vanguard senior economist. “Its labor market has faced challenges like those in the United States, with lingering COVID-related supply issues, and its energy-price shock has been worse than in the euro area, given domestic price-setting mechanisms. That’s why the Bank of England still has work to do to get inflation down toward target.”
We expect year-over-year core inflation, which excludes food and energy prices, to end the year at around 4.9% and to average 5.3% in the fourth quarter, still well above the BOE’s 2% target.
We foresee zero economic growth for the full year. Our base case is for recession in 2023, though the likelihood has increased that recession may be delayed into 2024. Resilience is partly attributable to changes in the U.K. mortgage market since the 2008 global financial crisis. Fewer households hold mortgages today, and among those that do, more have rates that are fixed for 2 or 5 years rather than variable. As such, higher interest rates take longer to affect households.
China
Official data released on July 17 put an exclamation point on China’s relatively weak economic performance. Gross domestic product (GDP) grew 6.3% in the second quarter compared with a year earlier, but that was a percentage point below analysts’ consensus estimate. Although growth topped the first quarter’s 4.5% pace, it owed in large part to favorable year-earlier comparisons. More telling: Compared with the first quarter, GDP grew just 0.8%.
We recently lowered our full-year growth forecast to a range of 5.5%–6.0%. Uncertainties around meaningful policy stimulus pose a downside risk not only to our forecast but also to the government growth target of “around 5.0%.” Developments at the Politburo meeting scheduled for the end of July will say a lot about the potential for further downside.
“We anticipate further stimulus measures to remain relatively modest,” said Grant Feng, a Vanguard senior economist. “That could take the form of expanded policy bank financing for high-end manufacturing and the green sector, a modest policy rate cut of 10 to 20 basis points, and further relaxation of housing purchase restrictions.”
Consumer prices fell for a third consecutive month in June and were flat compared with a year earlier. Producer prices, meanwhile, were down by a greater-than-expected 5.0% year-over-year in June. We foresee full-year headline inflation in a range of 1.0%–1.5% and core inflation, which excludes food and energy prices, of 1.0%.
Emerging Markets
Emerging markets
Emerging markets led the global rate-hiking cycle. As tighter monetary policy conditions cause economies to slow and help inflation recede toward central bank targets, we expect emerging markets to lead the rate-cutting cycle as well. That development could play out this month in Chile, where minutes of the June meeting of Banco Central Chile indicate the possibility of multiple rate cuts this year.
“Chile’s central bank is likely to be the first in Latin America to cut rates,” said Vytas Maciulis, a Vanguard economist. “Inflation, though still high, has fallen consistently, inflation expectations have dropped to the bank’s 3% target, and the broad economy has faltered.”
The Bank of Mexico left the target for its overnight interbank rate unchanged at 11.25% in June. The rate target remains more than 7 percentage points higher than where it stood when the bank’s hiking cycle began in June 2021. We believe the bank is likely to have reached its rate peak but don’t anticipate rate cuts in 2023.
We anticipate global emerging markets growth of 3.90% in 2023, but the recent economic developments in China, the world’s second-largest economy, bear watching. We foresee emerging Asia leading the way with 2023 growth of around 5.25%. We anticipate growth of about 1.50% in Latin America and of around 1.00% in central Europe, the Middle East, and Africa.
Download
Vanguard perspectives series
For more expert insights, check out:
Portfolio perspectives : Address evolving issues that may affect your clients’ portfolios with monthly updates from our Portfolio Solutions team.
Active fixed income perspectives : View our quarterly, in-depth commentary for a sector-by-sector analysis and a summary of how those views affect the Vanguard active bond funds.
Notes:
All investing is subject to risk, including the possible loss of the money you invest.
Investments in bonds are subject to interest rate, credit, and inflation risk.
Investments in stocks and bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.
IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.
The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.
The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.
Single Line Text
Vanguard Perspective. |. July 27, 2023. Explore by section. Projected returns. United States. Europe. United Kingdom. China. Emerging Markets. The views below are those of the global economics and markets team of Vanguard Investment Strategy Group as of July 19, 2023. Key highlights. Recent inflation and labor reports suggest some cooling in the economy ahead of the Fed’s July monetary policy announcement. Wage growth remained strong as the demand for workers continues to outstrip labor supply. We recently lowered our forecast for full-year economic growth in China to 5.5%–6.0%. Looking for our midyear outlook, view it here . Projected returns. Vanguard’s outlook for financial markets. Our 10-year annualized nominal return and volatility forecasts are shown below. They are based on the March 31, 2023, running of the Vanguard Capital Markets Model ® (VCMM). Equity returns reflect a 2-point range around the 50th percentile of the distribution of probable outcomes. Fixed income returns reflect a 1-point range around the 50th percentile. More extreme returns are possible. Equities. Return projection. Median volatility. U.S. equities. 4.1%–6.1% 17.0% U.S. value. 4.4%–6.4% 19.6% U.S. growth. 1.4%–3.4% 18.2% U.S. large-cap. 4.1%–6.1% 16.7% U.S. small-cap. 4.4%–6.4% 22.3% U.S. real estate investment trusts. 4.4%–6.4% 20.1% Global equities ex-U.S. (unhedged) 6.4%–8.4% 18.2% Global ex-U.S. developed markets equities (unhedged) 6.1%–8.1% 16.6% Emerging markets equities (unhedged) 6.1%–8.1% 25.9% Fixed income. Return projection. Median volatility. U.S. aggregate bonds. 3.6%–4.6% 5.5% U.S. Treasury bonds. 3.3%–4.3% 5.7% U.S. intermediate credit bonds. 4.2%–5.2% 5.2% U.S. high-yield corporate bonds. 5.5%–6.5% 10.1% U.S. Treasury Inflation-Protected Securities. 2.7%–3.7% 5.0% U.S. cash. 3.0%–4.0% 1.4% Global bonds ex-U.S. (hedged) 3.6%–4.6% 4.4% Emerging markets sovereign bonds. 5.6%–6.6% 10.9% U.S. inflation. 2.0%–3.0% 2.3% Notes: These probabilistic return assumptions depend on current market conditions and, as such, may change over time. Source: Vanguard Investment Strategy Group. IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of March 31, 2023. Results from the model may vary with each use and over time. For more information, see the Notes section at the end of this article. Region-by-region outlook. United States. United States. The most recent inflation and labor reports suggest some cooling in the economy ahead of a July 26 monetary policy announcement by the Federal Reserve. The Consumer Price Index rose 3.0% on a year-over-year basis in June, down from 4% in May. Core prices, which exclude food and energy, were 4.8% higher, down from 5.3% the month before. However, the path to the Fed’s 2.0% inflation target is likely to be long and winding. We expect year-over-year core inflation to finish 2023 around 3.3%, and that it will not fall below 2.0% until 2025. Employers added 209,000 jobs in June, the fewest since December 2020, when there were net job losses. But the unemployment rate fell to 3.6%, within the 3.4%–3.7% range that has prevailed since March 2022. Wage growth remained strong—average hourly earnings were up 4.4% year-over-year in June—as the demand for workers continues to outstrip labor supply. We believe that gives Fed policymakers impetus to raise their target for short-term interest rates by 25 basis points (0.25 percentage point) on July 26. At its last monetary policy meeting, on June 14, the Federal Open Market Committee voted to pause its interest rate hiking cycle, holding its rate target to a range of 5.00%–5.25%. In its “dot plot,” an aggregation of Fed officials’ individual views, the Fed suggested its rate target would be 5.50%–5.75% by year-end. That’s 25 basis points above our 5.25%–5.50% forecast range. The neutral rate of interest in the United States may be higher than many people think—including Federal Reserve policymakers. That is among the findings of new Vanguard research that suggests current monetary policy may be less restrictive than generally assumed. Demographics began to push the neutral rate higher before the COVID-19 pandemic, the research finds, and fiscal deficits have accelerated the rise since. The dividing line between tight and loose monetary policy may be higher than policymakers think. Notes : The Laubach-Williams and Holston-Laubach-Williams estimates of the U.S. neutral rate of interest are derived from Federal Reserve Bank of New York models. The Vanguard estimate is based on 2023 research by Joseph H. Davis, Ryan Zalla, Joana Rocha, and Josh Hirt. Sources : Vanguard and Federal Reserve Bank of New York model estimates of the neutral rate through 2022. The neutral rate is the theoretical central bank interest rate target that would neither restrict nor fuel activity in an economy at full employment. Assessments of the neutral rate, also known as R-star, are essential to policy-setting. Vanguard’s neutral-rate estimate is about half a percentage point higher than the estimate produced by the Laubach-Williams model, the Fed’s most frequently cited neutral rate source, named for its economist authors. We ran our higher neutral-rate assessment through the Fed’s macroeconomic model under a range of monetary policy rules. The results suggested that the median effective rate target would peak at 6.00% in 2023. The Fed’s current rate target is 5.00%–5.25%. In the longer term, the median central bank target rate would need to settle at 3.5%, or a full percentage point higher than the median long-run outlook in the Fed’s most recent Summary of Economic Projections . These “higher for longer” findings support the idea put forth by Joe Davis, Vanguard’s global chief economist, in his January Wall Street Journal  commentary  (subscription required) suggesting that long-term investors stand to benefit from a new era of “sound money.” Europe. Euro area. Weak recent data, especially from Germany, the euro area’s largest economy, suggest that a recession continued between April and June, marking a third consecutive quarterly contraction. “Weakness in the euro area has been broad-based across manufacturing and services,” said Shaan Raithatha, a Vanguard senior economist. “That’s consistent with another mild quarterly contraction in GDP, which would extend the recession.” We expect the peak impact of monetary policy tightening to take hold in the second half of 2023, with the labor market weakening in the European Central Bank’s (ECB’s) continuing quest to bring inflation to its 2% target. We continue to anticipate full-year economic growth of 0.5%, though risks are now skewed to the downside. The pace of both headline and core inflation, which excludes energy, food, alcohol, and tobacco prices, stood at 5.5% on a year-over-year basis in June. We believe that still-too-high inflation will lead the ECB to raise its deposit facility rate by a further 25–50 basis points to a peak of 3.75%–4%, with no rate cuts until mid-2024. United Kingdom. A day after government data showed an unexpected rise in core inflation, the Bank of England (BOE) on June 22 announced a 50-basis-point (0.5 percentage point) increase in the bank rate, to 5%. We recently raised our forecast for the BOE’s peak rate by 75 basis points to a range of 5.5%–5.75%, given the stronger-than-expected inflation data, a continued tight labor market, and accelerating wage growth. We maintain our view that the BOE will not lower its rate target until mid-2024 at the earliest. “The U.K. has had the worst of both worlds when it comes to inflation,” said Shaan Raithatha, a Vanguard senior economist. “Its labor market has faced challenges like those in the United States, with lingering COVID-related supply issues, and its energy-price shock has been worse than in the euro area, given domestic price-setting mechanisms. That’s why the Bank of England still has work to do to get inflation down toward target.” We expect year-over-year core inflation, which excludes food and energy prices, to end the year at around 4.9% and to average 5.3% in the fourth quarter, still well above the BOE’s 2% target. We foresee zero economic growth for the full year. Our base case is for recession in 2023, though the likelihood has increased that recession may be delayed into 2024. Resilience is partly attributable to changes in the U.K. mortgage market since the 2008 global financial crisis. Fewer households hold mortgages today, and among those that do, more have rates that are fixed for 2 or 5 years rather than variable. As such, higher interest rates take longer to affect households. China. Official data released on July 17 put an exclamation point on China’s relatively weak economic performance. Gross domestic product (GDP) grew 6.3% in the second quarter compared with a year earlier, but that was a percentage point below analysts’ consensus estimate. Although growth topped the first quarter’s 4.5% pace, it owed in large part to favorable year-earlier comparisons. More telling: Compared with the first quarter, GDP grew just 0.8%. We recently lowered our full-year growth forecast to a range of 5.5%–6.0%. Uncertainties around meaningful policy stimulus pose a downside risk not only to our forecast but also to the government growth target of “around 5.0%.” Developments at the Politburo meeting scheduled for the end of July will say a lot about the potential for further downside. “We anticipate further stimulus measures to remain relatively modest,” said Grant Feng, a Vanguard senior economist. “That could take the form of expanded policy bank financing for high-end manufacturing and the green sector, a modest policy rate cut of 10 to 20 basis points, and further relaxation of housing purchase restrictions.” Consumer prices fell for a third consecutive month in June and were flat compared with a year earlier. Producer prices, meanwhile, were down by a greater-than-expected 5.0% year-over-year in June. We foresee full-year headline inflation in a range of 1.0%–1.5% and core inflation, which excludes food and energy prices, of 1.0%. Emerging Markets. Emerging markets. Emerging markets led the global rate-hiking cycle. As tighter monetary policy conditions cause economies to slow and help inflation recede toward central bank targets, we expect emerging markets to lead the rate-cutting cycle as well. That development could play out this month in Chile, where minutes of the June meeting of Banco Central Chile indicate the possibility of multiple rate cuts this year. “Chile’s central bank is likely to be the first in Latin America to cut rates,” said Vytas Maciulis, a Vanguard economist. “Inflation, though still high, has fallen consistently, inflation expectations have dropped to the bank’s 3% target, and the broad economy has faltered.” The Bank of Mexico left the target for its overnight interbank rate unchanged at 11.25% in June. The rate target remains more than 7 percentage points higher than where it stood when the bank’s hiking cycle began in June 2021. We believe the bank is likely to have reached its rate peak but don’t anticipate rate cuts in 2023. We anticipate global emerging markets growth of 3.90% in 2023, but the recent economic developments in China, the world’s second-largest economy, bear watching. We foresee emerging Asia leading the way with 2023 growth of around 5.25%. We anticipate growth of about 1.50% in Latin America and of around 1.00% in central Europe, the Middle East, and Africa. PDF. Download. Vanguard perspectives series. For more expert insights, check out: Portfolio perspectives : Address evolving issues that may affect your clients’ portfolios with monthly updates from our Portfolio Solutions team. Active fixed income perspectives : View our quarterly, in-depth commentary for a sector-by-sector analysis and a summary of how those views affect the Vanguard active bond funds. Notes: All investing is subject to risk, including the possible loss of the money you invest. Investments in bonds are subject to interest rate, credit, and inflation risk. Investments in stocks and bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets. IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time. The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based. The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.