Read Vanguard’s latest forecasts for investment returns and our region-by-region economic outlook.
Forecast changes include expectations for:
Australia’s inflation rate to fall to around 4.5 per cent by year end as higher interest rates dampen demand.
China’s expected recovery in consumption to accelerate inflation this year, though not beyond its 3 per cent target.
The U.S. Federal Reserve Bank to increase its rate target by 50 basis points over its next two meetings (in March and May), to a range of 5 per cent–5.25 per cent, and to keep it there through year-end.
The views below are those of the global economics and markets team of Vanguard Investment Strategy Group.
Vanguard’s outlook for financial markets
Our 10-year annualised nominal return and volatility forecasts are shown below. They are based on the December 31, 2022, 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.
Region-by-region outlook…
Australia
The Reserve Bank of Australia (RBA) increased its target for the cash rate by 25 basis points, to 3.60 per cent on 7 March.
Given rising wage pressures, we believe the RBA will raise the cash rate to 3.85 per cent, extending the hiking cycle that began in May 2022 and has resulted in 350 basis points of increases.
We expect 1.0 per cent–1.5 per cent economic growth in 2023—less than the 1.8 per cent consensus estimate—with higher interest rates dampening Australia’s growth.
Just as it took longer for inflation to take hold in Australia, the timing of the disinflation process trails that of developed-market peers. Headline inflation accelerated to 7.8 per cent, annualised, in the fourth quarter. If it does not prove to be the peak, however, the fastest rate of price increases since 1990 should be close to it.
By year-end 2023, headline inflation likely will fall to around 4.5 per cent, as higher interest rates dampen demand. Price rises should then fall back to the RBA’s 2 per cent–3 per cent target band in 2024, though this hinges on wage growth.
China
China has rapidly moved away from its zero-COVID policy. As in developed markets, though to a lesser degree, consumers are poised to spend excess savings built during two years of widespread lockdowns. The effect likely will be a boost to domestic growth if not a reduced likelihood of global recession, according to Vanguard’s Asia-Pacific chief economist, Qian Wang.
We expect China’s GDP to grow by an above-consensus 5.3 per cent in 2023. Increased service-sector activity related to the economy’s reopening should especially boost the first two quarters. But growth likely will slow to just below 5 per cent in 2024, as we remain pessimistic about China’s structural outlook.
The expected recovery in consumption this year is likely to accelerate inflation, though not beyond China’s 3 per cent target. We foresee 2023 headline inflation around 2.5 per cent, held back by moderating food prices and appreciation in China’s currency. We expect core inflation to average 1.5 per cent in 2023.
We expect broad policy settings to shift from somewhat accommodative to more neutral late in the first quarter. Targeted growth support remains likely, however, such as in the property market to revive demand and limit developer defaults. But we expect continued deleveraging in the sector.
Euro area
Fast-falling natural-gas prices, a resilient industrial sector, and the reopening of China’s economy are mitigating an otherwise challenging euro area outlook. We continue to expect a recession, beginning this quarter, though we believe it will last just two quarters. We now forecast 0 per cent change in regional economic output in 2023, an upgrade from our previous expectation of a 0.5 per cent–1 per cent contraction. We foresee euro area growth of about 0.7 per cent in 2024.
We’ve lowered our forecast for headline inflation in 2023—to an average of 4.5 per cent, down from 6.1 per cent—largely because of an almost 85 per cent decline in natural-gas prices since their August 2022 peak. Our view is well below a consensus view of 5.7 per cent, which we expect will come down in the weeks ahead.
We continue to foresee core inflation, which excludes volatile food and energy, averaging 4 per cent in 2023. Service-sector wage pressures are likely to remain strong, given a historically tight labor market.
On February 2, the European Central Bank (ECB) increased its deposit facility rate by 50 basis points, to 2.5 per cent, and said it intends to raise the rate to 3.0 per cent on March 16. We expect the ECB to raise the key rate to 3.5 per cent in the second quarter of 2023, with two more, 25-basis-point rate hikes. Rate cuts are likely to arrive in the second half of 2024 at the earliest.
The energy shock from Russia’s 2022 invasion of Ukraine, meanwhile, appears milder than initially feared. Natural-gas prices are down, and the region has adapted well to significantly lower Russian energy imports. But Europe’s energy crisis isn't over, according to Shaan Raithatha, a London-based Vanguard senior economist.
United Kingdom
To see the effect of tighter monetary policy on the U.K. economy, look no further than the housing market. Mortgage approvals fell in December for a fourth straight month to the lowest level since May 2020, as the effective interest rate on new mortgages rose by 32 basis points, to 3.67 per cent. More than 750,000 homeowners are at risk of defaulting on their mortgages in the next two years, the country’s main financial regulator has warned.
We expect the Bank of England (BOE) to lift its bank rate to 4.5 per cent in May and keep it there until the second half of 2024. Our view is contrary to that of markets pricing in rate cuts in the second half of 2023.
Rising wages likely will continue to play into the BOE’s decision-making. In the private sector, which accounts for more than 80 per cent of total employment, average regular pay grew by 7.3 per cent in the fourth quarter.
Goods and services prices were 10.1 per cent higher in January than a year earlier, continuing to ease from their October 2022 peak but still far above the BOE’s target. We expect headline inflation to average 6 per cent–6.5 per cent in 2023.
We believe that a recession likely has begun this quarter in the United Kingdom and will persist through the third quarter of 2023. We continue to expect GDP to contract by 1 per cent in 2023 before growing about 0.6 per cent in 2024.
United States
Clearly, the nearly year-long, 450-basis-point cycle of interest rate hikes by the Federal Reserve hasn’t materially affected the labour market. Consider year-end Bureau of Labor Statistics’ adjustments that suggested an even stronger labour market in 2022 than initially reported. Or the reported creation of 517,000 jobs in January and the fall in unemployment rate to a 54-year low of 3.4 per cent.
Changes in monetary policy take time to work through an economy, however, and we expect higher interest rates to cool the labour market in the second quarter. We anticipate job losses in the second half of 2023 and an unemployment rate near 5 per cent by year-end.
We continue to expect the Fed to increase its rate target by a total of 50 basis points over its next two meetings (in March and May), to a range of 5 per cent–5.25 per cent, and to keep it there through year-end.
The Consumer Price Index stood 6.4 per cent higher in January than a year earlier, down modestly from December’s 6.5 per cent year-over-year rise. We expect inflation to subside gradually through 2023, with higher shelter prices in the first half of the year offset to a degree by faster deceleration in goods prices.
We expect the Fed’s favoured inflation gauge, the core Personal Consumption Expenditures Index, to fall below 3 per cent by year-end 2023 and to 2 per cent by year-end 2024.
We continue to assign a high probability to a mild recession in 2023, though the odds of continuing economic growth—a “soft landing” from the Fed’s efforts to quell inflation—have risen.
Emerging markets
The reopening of China’s economy and the increased consumption we expect it to engender will likely benefit Asian emerging markets through tourism and trade.
We haven’t changed our below-consensus forecast for emerging markets GDP growth of 3 per cent in 2023. Our proprietary leading indicators index signals an upside growth risk for emerging markets, however; this would be felt most in emerging Asia and somewhat in Latin America, though likely not at all in emerging Europe, given broader economic challenges there.
Inflation likely has peaked in Latin America and neared its peak in emerging Asia, but inflation-related challenges haven’t gone away. The Bank of Mexico on February 9 cited a “slower-than-foreseen disinflationary process” in raising the target for its overnight interbank rate by 50 basis points to 11 per cent. The bank said it expects inflation to fall to its 3 per cent target only in the fourth quarter of 2024.
Headline inflation was 7.9 per cent in January in Mexico compared with a year earlier, higher than in both November and December though considerably lower than its 8.7 per cent September 2022 peak. Core inflation, at 8.45 per cent compared with a year earlier, was up from December’s level and near its November peak.
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.