Key points

  • Euro-area interest rates seen rising to 3.5% in second quarter amid strengthening underlying inflation.
  • Risk of US recession in 2023 remains at 90% with inflation worries still uppermost for Fed.
  • Despite a recent pickup in activity, the UK also seems on course for a recession in 2023.
  • However, China’s 2023 economic growth forecast raised to 5.3% after strong fourth quarter.


Monthly economic and market update


It’s been a month of contrasting fortunes for the world’s biggest economies with the prognosis for China improving as Covid measures unwind and recent euro-area activity data surprising to the upside, but the US and UK still on course for recession as central banks battle to contain inflation.

We have upgraded our forecast for economic growth in China to 5.3% from the 4.5% after a strong fourth-quarter performance, which comes as the country emerges from Covid lockdowns.

We had expected a bumpy, gradual exit from China’s zero-Covid approach, but policymakers now appear adamant about removing all controls, even as the virus overwhelms China’s health system.

In the United States, we still see a risk that higher wages could filter down into higher-than-expected core inflation later this year, even though average hourly earnings slowed to 4.6% in December. Headline consumer price inflation also slowed to 6.5% in December. Although we expect year-on-year headline inflation to continue to fall, we expect the next monthly reading to come in stronger as recent falls in used car prices moderate.

The minutes of the Federal Reserve’s last policy meeting on 13-14 December show that it remains more concerned with inflation than with the possibility of an overly restrictive policy that after a lag leads to an unnecessary reduction in economic activity. We continue to expect the US central bank to push its rate-target range higher to a peak of 5% to 5.25% during the first quarter, from 4.25% to 4.5% currently, and to keep it at that level for the rest of the year. We also still think that a US recession this year is 90% likely.

When the European Central Bank (ECB) increased its main deposit facility by 50 basis points to 2% in December it forecast that headline and core inflation (which excludes volatile food and energy prices) would on average remain above the bank’s 2% target through 2025. As a result, Vanguard now expects euro-area policy rates to peak at 3.5% in the second quarter, a percentage point higher than we expressed in our 2023 economic and market outlook. We also don’t expect them to be cut until the second half of 2024, at the earliest.

GDP in the euro area is now forecast to contract by 0.5% to 1% in 2023, but risks to this view are skewed to the upside given recent positive economic data surprises.

The need for tighter monetary policy amid elevated inflationary pressures is also one reason we believe the United Kingdom economy will enter a recession in 2023, even though recent economic data suggests it might have narrowly avoided a recession in 2022.

Vanguard continues to expect the Bank of England’s main policy rate to rise to 4.5% early in 2023 from 3.5% now, without more concrete signs of easing wage growth. The mortgage market may be the next point of pain for households after the energy-cost stresses of 2022. Vanguard estimates that, in a country where most mortgage rates are fixed for only two to five years, 35% to 40% of mortgage holders will have to reprice to sharply higher rates over the course of 2023.

The points above represent the house view of the Vanguard Investment Strategy Group’s (ISG’s) global economics and markets team as of 19 January, 2023. For a deeper dive into our economists’ latest thinking, please read the full report.

Asset-class return outlook

The following are Vanguard’s latest 10-year annualised outlooks for equity and fixed income returns1.


1 The probabilistic return assumptions depend on market conditions at the time of the running of the Vanguard Capital Markets Model® (VCMM) and, as such, can change with each running over time.

ISG updates these numbers quarterly. The projections listed above are based on a running of the VCMM based on data as of 30 September, 2022.  Please note that the figures are based on a 2-point range around the 50th percentile of the distribution of return outcomes for equities and a 1-point range around the 50th percentile for fixed income. Numbers in parentheses reflect median volatility.

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 30 September, 2022. Results from the model may vary with each use and over time.


Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Past performance is not a reliable indicator of future results.

IMPORTANT: The projections and 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. 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 US 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.

Important information

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The information contained in this article is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.  The information in this article does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this article when making any investment decisions.

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