March 23, 2023
Recent events in the U.S. and European banking sectors have not altered our macroeconomic views. The Federal Reserve still has work to do to bring down inflation—a task that was always going to be a challenge, likely to entail higher unemployment and tighter credit and financial conditions. Deterioration in financial conditions has long been part of our expectation for a modest recession later this year.
The views below are those of the global economics and markets team of Vanguard Investment Strategy Group as of March 23, 2023.
Our 10-year annualized 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.
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 December 31, 2022. Results from the model may vary with each use and over time. For more information, see the Notes section.
In its March 22 policy announcement, the Federal Reserve endorsed the health of the U.S. banking system but cautioned that recent developments were likely to result in tighter credit conditions and to weigh on economic activity. The Fed raised its target for short-term interest rates by 25 basis points (0.25 percentage point) to a range of 4.75%–5%.
A surprise move by the People’s Bank of China (PBoC) will inject liquidity into the banking system but doesn’t affect our outlook. The bank announced on March 17 that, effective March 27, it was cutting its reserve requirement ratio (RRR) by 25 basis points for large and medium-size banks with RRRs above 5%. We estimate the move will lower the banking system’s effective RRR to 7.6% and release about CNY 500 billion ($73 billion) of liquidity, resulting in modest bank-financing cost reductions.
When the European Central Bank (ECB) raised its key interest rate by 50 basis points, to a 15-year high of 3.0%, on March 16, it said “inflation is projected to remain too high for too long.” It emphasized that, because of recent stresses in the banking sector, it “stands ready to respond as necessary to preserve price stability and financial stability in the euro area.”
The Bank of England (BOE) raised the interest rate it pays on commercial bank deposits by 25 basis points to 4.25% on March 23. The bank noted in its statement that “global growth is expected to be stronger than projected in the February Monetary Policy Report, and core consumer price inflation in advanced economies has remained elevated.”
Stronger-than-expected current data and leading indicators in both developed and emerging markets have led us to increase our forecast of aggregate 2023 emerging markets GDP growth from about 3% to about 3.25%. Purchasing managers’ indexes and consumer spending data suggest that, like some developed markets, economies in emerging markets are holding up better than expected.
The effects of more restrictive monetary policy are starting to appear in Canada, perhaps more so than in other developed markets. Post-pandemic inventory rebuilds are slowing, housing and business investment is down, and leading indicators suggest a continued decline in economic activity.
The Reserve Bank of Australia (RBA) raised its interest rate target by 25 basis points to 3.6% on March 7, the tenth consecutive meeting with a rate increase and the highest target since June 2012. We expect another 25-basis-point hike on April 4 and that 3.85% will prove to be the central bank’s peak rate target, though risks appear skewed toward further rate increases.
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.