Monthly economic outlook
October 27, 2022
Vanguard believes the Federal Reserve will raise the federal funds rate to 4.5% by the end of the first quarter in 2023. Higher-than-expected core inflation in two recent quarters has led us to increase our forecast of year-end inflation in the United States. We expect the U.S. economy will grow around 1.8% over the next few quarters, while the euro area will likely enter a recession before year-end.
The points in this article represent the house view of Vanguard’s global economics and markets team as of October 19, 2022.
Our 10-year, annualized, nominal return projections for the major asset classes, as of September 30, 2022, are shown below. Projections based on the full September 30, 2022, running of the VCMM, which will include additional U.S. sub-asset classes, will be communicated in the December release of this monthly report. 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.
Notes: These probabilistic return assumptions depend on current market conditions and, as such, may change over time.
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 September 30, 2022. Results from the model may vary with each use and over time. For more information, see the Notes section.
Source: Vanguard Investment Strategy Group.
Vanguard expects a solidly positive number, perhaps above 2.5%, when the Bureau of Economic Analysis (BEA) reports its first estimate of third-quarter GDP in the United States on October 27.
Economic momentum has continued to deteriorate in the euro area in recent weeks, and Vanguard continues to expect a mild recession there this quarter, stretching into the first quarter of 2023.
Bond and currency markets soundly rejected a United Kingdom government growth plan announced on September 23 that included the largest package of tax cuts in generations.
An October 18 release of GDP and other data in China was postponed indefinitely and without explanation, signaling a potential de-emphasis on economic growth in favor of alternative policy objectives.
The growth story in emerging markets is one of relative resilience compared with that of developed markets. We foresee economic growth around 3.3% for both full-year 2022 and full-year 2023, below consensus but higher than our developed-market views.
An ever-more-hawkish Federal Reserve has led Vanguard to increase its view for the terminal rate, or end point, for the federal funds rate target. In our base case, we believe the Fed will raise the rate to 4.5% by the end of the first quarter of 2023, from a current target range of 3.00% to 3.25%.
Notes: Market expectations for central bank policy rates at a given time are represented by one-month forward swap rates. U.S. swaps are based on published overnight federal funds rate indexes. Euro area swaps are based on the published euro overnight index average. U.K. swaps are based on published overnight bank rate indexes. Neutral-rate ranges are Vanguard estimates. The neutral rate is the level at which policy interest rates would neither stimulate nor restrict an economy. Estimates of the neutral rate are determined by long-term economic factors and are subject to a wide band of statistical uncertainty. Estimates of the nominal neutral rate assume inflation of 2% in the United States, 1.8% in the euro area, and 2% in the United Kingdom. The Vanguard terminal rate is our view of the level at which central bank policy rates will peak during their interest rate tightening cycle.
Source: Vanguard analysis, as of October 14, 2022.
Higher-than-expected core inflation in two recent reports has led Vanguard to increase our view of the year-end level for core inflation in the United States. Core inflation in the September consumer price index (CPI) report surprised to the upside for a second consecutive month, rising by 0.6% from August and 6.6% compared with a year earlier, the highest level since 1982. (Core inflation excludes volatile food and energy prices and thus reflects broader price pressures in an economy.)
The unemployment rate fell to 3.5% in the United States in September, with the economy adding 263,000 jobs, the Bureau of Labor Statistics reported on October 7.
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Investments in stocks or 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 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.