• Investors can expect a more challenging macroeconomic environment in 2023 with a global recession as our base case.
  • Expectations around 10-year asset-class returns have improved and they are more attractive than a year ago.
  • Staying focused on a client’s long-term goals and sticking to the principles of good asset allocation across a globally diversified portfolio of stocks and bonds remains a prudent approach. 

 

Central banks and policymakers will continue to drive market conditions globally in 2023 in an effort to combat persistently high inflation, according to Vanguard economists.

The summary of our economic and market outlook for 2023 suggests that policymakers are willing to accept asset-price volatility and a deterioration in macroeconomic fundamentals as a consequence of fighting inflation.

Global conditions today and those anticipated in the coming months are similar to those that have signalled global recessions in the past and our base case is for a global recession in 2023. But failing to act aggressively to combat inflation risks harming households and businesses in the long term.

A recession by any other name

Energy supply-and-demand concerns, diminishing capital flows, declining trade volumes and falling output per person mean that, in all likelihood, the global economy will enter a recession in the coming year.

That said, households, businesses and financial institutions are in a much better position to handle an eventual downturn, to the extent that drawing on recent historical parallels seems misplaced. Although all recessions are painful, this one is unlikely to be historic.

Growth is likely to end 2023 flat or slightly negative in most major economies outside of China. Unemployment is likely to rise over the year but nowhere near as high as during the 2008 and 2020 downturns. Through job losses and slowing consumer demand, a downtrend in inflation is likely to persist through 2023.

 

GDP growth*

Unemployment rate

Headline inflation†

Monetary policy

 

2023

2023

2023

 

Country/region

Vanguard

Consensus

Trend

Vanguard

Consensus

NAIRU

Vanguard

Consensus

Year-end 2022

Year-end 2023

Neutral rate

US

0.25%–0.5%

0.9%

1.8%

4.4%

4.4%

3.5%–4%

3%

2.4%

4.25%

4.5%

2.5%

Euro area

0%

0.2%

1.2%

7.4%

7.1%

6.5%-7%

5.3%

5.2%

1.75%-2%

2.5%

1.5%

UK

-1% to -1.5%

-0.5%

1.7%

4.7%

4.4%

3.5%-4%

6.3%

6.5%

3.5%

4.5%

2.5%

China‡

4.5%

5%

4.3%

4.7%

N/A

5%

2.2%

2.3%

2.65%

2.6%

4.5%-5%

* For the US, GDP growth is defined as the year-over-year change in fourth-quarter Gross Domestic Product. For all other countries/regions, it is defined as the annual change in total GDP in the forecast year compared with the previous year.

† For the US, headline inflation is defined as year-over-year changes in this year’s fourth-quarter Personal Consumption Expenditures (PCE) Price Index compared with last year. For all other countries/regions, it is defined as the average annual change in headline Consumer Price Index (CPI) inflation in the forecast year compared with the previous year. Consensus for the US is based on Bloomberg ECFC consensus estimates.

‡ China’s policy rate is the one-year medium-term lending facility (MLF) rate.

Notes: Forecasts are as of 31 October 2022. NAIRU stands for non-accelerating inflation rate of unemployment.

Source: Vanguard.

Bond market outlook

We think central banks, including the Bank of England, European Central Bank and the US Federal Reserve, will continue to raise interest rates next year to combat inflation.

The eventual peak and persistence of interest rate rises, which will depend heavily on the path of inflation, will determine how high bond yields rise. While rising interest rates have created near-term pain for investors, higher starting interest rates have raised our return expectations for the asset class.

Using the Vanguard Capital Markets Model, which calculates our 10-year annualised return expectations1, we think domestic bonds will offer euro investors returns of between 2.2% and 3.2% – representing an increase on last year’s expectations (-0.5% to 0.5%). Global bonds (excluding euro-area bonds, hedged to euros) are expected to offer around 2.1% to 3.1% per annum over the next decade, up from -0.5% to 0.5% in last year’s annual forecast.

This means that for investors with an adequately long-term horizon, we expect their wealth to be higher by the end of the decade than our year-ago forecast would have suggested.

Equity market outlook

Rising interest rates, inflation and geopolitical risks have forced investors to reassess their rosy expectations for the future. The silver lining is that this year’s bear market has improved our outlook for global equities.

For euro investors, euro-area equities are likely to return between 4.9% and 6.9% per annum over the next decade, and global equities (ex-euro areas, unhedged) between 3.7% and 5.7%.

Against a challenging macroeconomic backdrop, it’s important to remember that staying focused on a client’s long-term goals and sticking to the principles of good asset allocation across a globally diversified portfolio of stocks and bonds remains a prudent approach.

 

1 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. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modelled asset class. Simulations as at 30 September 2022. Results from the model may vary with each use and over time.

Important information

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 as at September 2022. Results from the model may 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 US Treasury and corporate fixed income markets, international fixed income markets, US 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.

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.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Funds investing in fixed interest securities carry the risk of default on repayment and erosion of the capital value of your investment and the level of income may fluctuate. Movements in interest rates are likely to affect the capital value of fixed interest securities. Corporate bonds may provide higher yields but as such may carry greater credit risk increasing the risk of default on repayment and erosion of the capital value of your investment. The level of income may fluctuate and movements in interest rates are likely to affect the capital value of bonds.

Important information

For professional investors only (as defined under the MiFID II Directive) investing for their own account (including management companies (fund of funds) and professional clients investing on behalf of their discretionary clients). In Switzerland for professional investors only. Not to be distributed to the public.

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