Our investment and economic outlook, December 2023

“Older workers have been a boon to supply since about 2016,” said Adam Schickling, a Vanguard senior economist. “As a result, they’ve helped keep wages and, in turn, broader inflationary pressures lower than they might have been.” The elevated participation rate for older workers faces headwinds in coming years as the cohort collectively ages, as the top line in the chart suggests, but we expect the dynamic of retirement postponement to persist through 2024, putting upward pressure on the unemployment rate as more people seek available jobs.

“It’s important to put this increase in perspective,” Schickling said. “A 5% unemployment rate would still represent a strong labor market by historical standards. This modest loosening, however, is a bit of good luck for the Federal Reserve as it aims to bring inflation back to its 2% target.”

The views below are those of the global economics and markets team of Vanguard Investment Strategy Group as of December 21, 2023.

Our 10-year annualized nominal return and volatility forecasts are shown below. They are based on the September 30, 2023, running of the Vanguard Capital Markets Model® (VCMM). Equity returns reflect a range of 2 percentage points around the 50^th percentile of the distribution of probable outcomes. Fixed income returns reflect a 1-point range around the 50^th percentile. More extreme returns are possible. 

The Federal Reserve cheered markets with its policy rate decision on December 13 to maintain the federal funds rate at the 5.25%–5.5% range and by suggesting it had reached the peak of a rate-hiking cycle that began in March 2022. Its summary of economic projections suggested that the Fed would initiate three 25-basis-point cuts to its rate target in 2024. (A basis point is one-hundredth of a percentage point.) Vanguard, too, believes that the Fed will cut its rate target in 2024, but to a greater degree than the Fed signaled. We foresee the equivalent of six to eight quarter-point cuts—a total of 150 to 200 basis points—driven not by a soft landing but by the onset of a mild recession late in the year. We foresee full-year 2024 GDP growth in a range of 0.25%–0.75%.

• The Fed maintained its forecast of a 2024 unemployment rate of 4.1%. We believe that a higher unemployment rate than the Fed envisions would be commensurate with a contraction in GDP growth. We foresee a 2024 year-end unemployment rate of 4.8%. For now, the labor market appears healthy. The U.S. economy added 199,000 jobs in November, and the unemployment rate fell back to 3.7%, from 3.9% in October. We nonetheless see a softening. The health care/social assistance sector represents 16% of the labor force but has accounted for 70% of job growth in the last six months, a level we don’t see as sustainable.

• The nation’s real GDP annual growth rate in the third quarter was downwardly revised to a still robust 4.9%, according to the third estimate by the Bureau of Economic Analysis, reflecting a downward revision in consumer spending. While lower than the prior estimate of 5.2%, it’s still significantly higher than second-quarter real GDP growth of 2.1%.

• Headline inflation as measured by the Consumer Price Index (CPI) increased by 0.1% in November on a seasonally adjusted basis compared with October. The index rose by 3.1% compared with a year earlier. Core CPI inflation, which excludes volatile food and energy prices, rose 0.3% in the month and 4% compared with a year earlier. The Fed forecast that core inflation would fall to 2.4% in 2024, a greater deceleration than it had forecast in September.

• Core inflation as measured by the separate Personal Consumption Expenditures (PCE) index—the Fed’s preferred inflation measure in considering its monetary policy stance—rose by 3.5% in October, down from 3.7% in September. At an annualized monthly rate, core PCE has been below 3% for four consecutive months. Vanguard foresees core PCE falling to 2.3% by the end of 2024, still just above the Fed’s 2% target.
  

Canada’s economy contracted in the third quarter compared with the second, but it avoided falling into a technical recession because second-quarter economic activity was revised from negative to positive. GDP fell by 0.3% in the third quarter (1.1% on an annualized basis) down from a 0.3% increase in the second quarter (1.4% on an annualized basis). We foresee Canada falling into a mild recession early in 2024, with recovery later in the year in response to expected monetary policy rate cuts. We anticipate full-year 2024 growth around 1%. 

• The Bank of Canada on December 6 held its overnight rate steady at 5.0% for a third straight meeting. Although inflation broadly is slowing, shelter price inflation has increased, reflecting faster growth in rent and continued contributions from higher mortgage costs. We foresee the BOC leading a developed markets rate-cutting cycle as inflation eases and GDP contracts. We anticipate that cuts could as much as halve the overnight rate, to a range of 2.5%–3%, by the end of 2024.

• The pace of headline inflation registered 3.1% year-over-year in November, the same level as in October and down from 3.8% in September. Gasoline prices were down by 7.7% year-over-year, nearly matching October’s 8% fall. But services inflation remained elevated at 4.6% year-over-year, the same as in October and up from 3.9% in September. Core inflation, which excludes volatile food and energy prices, increased by 0.4% on a monthly basis and registered 3.5% year-over-year, slightly higher than 3.4% in October. We foresee the pace of core inflation slowing in 2024, to a range of 2%–2.5%, within the BOC’s target range, as housing prices moderate in response to declining affordability. A loosening in the labor market should ease wage pressures.

• The unemployment rate rose again in November, by a tenth of a percentage point, to 5.8%. The rate has risen steadily over the last seven months after holding at 5% the first four months of the year. Canada’s economy created 25,000 jobs, but population growth continued to outpace employment growth. We foresee the unemployment rate rising to a range of 6%–6.5% in 2024.

Downside surprises to inflation and economic activity data have led markets to price in earlier and more significant policy interest rate cuts than we believe is warranted. There’s still a way to go for core inflation to fall to the 2% target set by the European Central Bank (ECB), and the ECB’s own model is consistent with our view on the timing of rate cuts. We believe rate cuts will begin mid-year and will total 75 basis points in 2024.

• For now, the ECB left its deposit facility rate unchanged at 4% on December 14. The ECB also announced it would reduce its assets under the Pandemic Emergency Purchase Programme (PEPP) by an average €7.5 billion per month over the second half of 2024. It intends to unwind the program passively by discontinuing reinvestments at the end of 2024.  

• GDP contracted by 0.1% on a seasonally adjusted basis in the third quarter compared with the second. We continue to expect subdued, below-trend growth as the bite from contractionary monetary and fiscal policy intensifies. As inflation falls, however, we expect economic activity to eventually receive a modest boost from gains in real wage growth. We foresee full-year 2024 GDP growth of 0.5%–1%.

• Headline inflation slowed to a 2.4% pace in November compared with a year earlier, down from 2.9% in October. On a monthly basis, broad prices fell by 0.6% compared with a 0.1% gain in October. Core inflation, which excludes volatile food and energy prices, registered 3.6% compared with a year earlier, down from a 4.2% year-over-year gain in October. On a monthly basis, prices of core items fell by 0.6%. We foresee core inflation falling to near the ECB’s 2% target by the end of 2024.  

• The unemployment rate registered 6.5% in October, down from 6.6% in September. We anticipate a softening in the labor market as economic activity falls below its potential amid restrictive monetary and fiscal policy. We expect the unemployment rate to rise to an above-consensus range of 7%–7.5% in 2024, reflecting our skepticism that a “painless disinflation” is attainable.

Recent official economic growth estimates give us greater conviction that the U.K. economy will fall into recession in late 2023 or early 2024. The first estimate of third-quarter GDP showed growth slowing to a standstill compared with the second quarter. On a monthly basis, GDP is estimated to have fallen by 0.3% in October compared with September. We foresee below-trend GDP growth in a range of 0.5%–1% in 2024 as the effects of contractionary monetary and fiscal policy are fully felt. As inflation falls, however, we expect economic activity to receive a modest boost from gains in real wage growth.

• Inflation decelerated further in November, according to Office for National Statistics (ONS) data. The pace of headline inflation as measured by the Consumer Prices Index slowed to 3.9% compared with a year earlier, lower than the 4.6% pace in October. Compared with a month earlier, the CPI decreased by 0.2% from October. The pace of core inflation—which excludes volatile food, energy, alcohol, and tobacco prices—slowed to 5.1%, down from 5.7% in October.

• In maintaining the bank rate at 5.25% for a third straight meeting on December 14, the Bank of England (BOE) said risks to its inflation projection still skew to the upside. Three of the nine Monetary Policy Committee voting members again preferred a 25-basis-point rate increase. With services inflation elevated and wage growth resilient, we expect the bank rate will need to stay at its current level for an extended period. We don’t foresee the BOE being in position to cut the bank rate until mid-2024 at the earliest.

• The unemployment rate was unchanged at 4.2% in the August-to-October period, the ONS reported. Job vacancies had declined by 45,000 in the September-to-November period and had fallen in 16 of the 18 industry sectors. Workers’ regular earnings (excluding bonuses) rose by 7.3% on an annualized basis in the August-to-October period, a still-high figure that the BOE will no doubt be watching in considering monetary policy.

We expect that coordinated fiscal, monetary, and regulatory stimulus will be required to drive China’s economy toward the 5% growth in 2024 that we expect the central government to target. The latest economic release underscores the need for such stimulus. For 2024, we foresee economic growth of 4.5%–5%, core inflation of 1%–1.5%, a 2.2% 1-year medium term lending facility rate to end the year, and a year-end unemployment rate around 4.8%.

• Retail sales grew by 10.1% in November compared with a year earlier, higher than the 7.6% growth in October. But both figures benefited from base effects, or comparisons with year-earlier numbers that were depressed because China remained in the throes of widespread COVID-19 lockdowns in late 2022. The November retail sales figures, which were held back by consumer price deflation, were well below expectations and down on a sequential basis, by 0.1% compared with October.

• The property sector remains challenged, absent signs of pickup in sales values or volumes, and with little indication of progress in completing existing projects. Property sales volumes fell by 21.3% year-over-year in November and values by 16.9%, though housing starts increased by 4.7% year-over-year compared with a 21.2% decrease in October. Vanguard believes that the lack of new discussions on the property sector at this month’s Central Economic Work Conference may indicate that policymakers are still exploring ways to ensure the sector’s stable development.

• Industrial production was a bright spot, up 6.6% year-over-year in November, higher than a 4.6% gain in October. We expect recently announced stimulus measures to take time to work through the economy. Policy bias toward production and investment exacerbates supply and demand imbalances. As a result, we expect deflation to linger in the near term. Consumer prices fell for a second straight month in November. Both year-over-year and month-over-month prices were down by 0.5%. Producer prices have fallen on a year-over-year basis for the last seven months.
  

The Reserve Bank of Australia (RBA) may have reached the peak of its rate-hiking cycle, though risks skew toward a further increase in 2024. The RBA left its cash rate unchanged at 4.35% in its final policy meeting of 2023. The move came after a 25-basis-point increase in November.

• The greatest risk to the RBA’s efforts is that core inflation isn’t falling quickly enough. The pace of headline inflation slowed in October, to 4.9%, on a year-over-year basis, down from a 5.6% pace in September. But trimmed mean inflation—a measure of core inflation that excludes extremes in monthly price changes—was 5.3%, down only slightly from September’s 5.4% reading. We foresee headline and core inflation reaching the midpoint of the RBA’s 2%–3% target range only in 2025, and a further rate increase may be required to help get it there. Eventually, however, as inflation does move toward target, we foresee the RBA being able to cut rates in the second half of 2024, on the way to a policy rate around 3.85% to end 2024.

• GDP grew by just 0.2% on a seasonally adjusted basis in the third quarter compared with the second, the Australia Bureau of Statistics reported December 6. It was the third straight quarter of decelerating growth. On a year-over-year basis, GDP grew by 2.1%. We expect GDP growth of 0.75%–1.25% for all of 2024, with about a 40% probability of a recession over the next 12 months.

• The unemployment rate rose to 3.9% on a seasonally adjusted basis in November, up from 3.7% in October. We expect an unemployment rate that touched 50-year lows after the pandemic to rise throughout 2024 as financial conditions continue to tighten in a higher-rate environment.
  

Emerging markets were first to raise interest rates in the last global rate-hiking cycle, and they’re leading the cutting cycle, too. We expect central banks in Latin America and emerging Europe to cut rates modestly through 2024, with banks in emerging Asia to remain on pause until the second half of the year. We expect emerging markets GDP to grow mostly in line with consensus in 2024 and to a greater degree than that of developed markets. We anticipate growth of around 4% for emerging markets broadly—around 5% for emerging Asia and 2%–2.5% for emerging Europe and Latin America.

• One Latin American central bank yet to join the rate-cutting ranks is the Bank of Mexico (Banxico), which left its target for the overnight interbank rate unchanged at 11.25% for a sixth consecutive policy meeting on December 14. Core inflation continued its downward trend in November, slowing for a 10th consecutive month to a year-over-year pace of 5.3%. The pace of headline inflation inched higher, to 4.32% from 4.26% in October, driven by an increase in electricity prices as summertime subsidies for some urban dwellers ended. Although manufacturing has weakened, Mexico’s consumers remain resilient. Vanguard believes that Banxico will remain data-dependent in determining when to join regional counterparts Brazil and Chile in cutting interest rates, perhaps by the end of the first quarter of 2024.

• Banco Central do Brasil reduced its policy rate by 50 basis points for a fourth straight meeting on December 13, to 11.75%. The bank anticipates further reductions in future meetings. It noted that various measures of underlying inflation had fallen closer to its inflation target, which is 3% for 2024 and 2025. The bank foresees inflation falling to 3.5% in 2024 and 3.2% in 2025.

• Banco Central Chile lowered its policy interest rate by 75 basis points on December 19, to 8.25%. The bank noted a recent fall in U.S. long-term interest rates and said “this decline has been passed on to the rest of the countries.” The pace of annual headline inflation slowed to 4.8% in November from 5% in October, though the monthly pace of increase was higher in November, at 0.7% compared with 0.4% in October.  

• Narodowy Bank Polski, Poland’s central bank, kept its reference rate unchanged at 5.75% on December 6. Although it foresees a gradual decline in domestic inflation, it kept the rate steady for a second straight month, having reduced it by a percentage point since June and with annual headline inflation still elevated at 6.5% in November.

• Magyar Nemzeti Bank, Hungary’s central bank, announced a reduction of 75 basis points in its central bank base rate on December 19. Inflation in Hungary has fallen from more than 25% year-over-year at the start of 2023 to 7.9% in November.

• Three economists on U.S. growth, inflation, and labor (article, issued December 2023)
• Vanguard economic and market outlook for 2024: A return to sound money (24-page PDF, issued December 2023)
• Our economic and market outlook for 2024 (hub, issued December 2023)
• Why investors benefit from a return to sound money (3:51 video, issued December 2023)