Vanguard economic and market update
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E C O N O M I C A N D M A R K E T U P D AT E | A U G U S T 2 0 2 0
Vanguard economic
and market update
Vanguard’s key points:
• The initial stages of recovery from the Covid-19 • Inflation is picking up, but we don’t expect this to be
pandemic in the US, Europe and Asia have been the start of a meaningful trend.
slightly faster than anticipated.
• Trade has bounced off its lows, with our index
• However, we expect the pace of recovery to slow of leading indicators increasing for a third
later in the year, meaning monetary policy should consecutive month.
remain loose well into 2021.
Economic growth We believe the strength of the recovery will
depend on the implementation of additional
Second-quarter GDP numbers came in largely
fiscal support and advocate that it be targeted
as expected, with the global economy having
at struggling businesses and households to
experienced its sharpest contraction since the
minimise permanent effects to the economy,
Great Depression. The world’s attention now
or “scarring.”
turns to the third quarter and the pace of recovery.
Recent data releases suggest that the initial stages • The euro area economy contracted by –12.1%
of recovery in the United States, Europe and the in the second quarter compared with the first
Asia-Pacific are proceeding at a slightly faster pace quarter, according to preliminary estimates.
than we had anticipated. However, as signs emerge Retail sales of both durable and non-durable
of second waves of Covid-19 infection, we expect goods offer a hint of promise, especially in
the pace of recovery to slow later in the year as Germany, where they’ve reached pre-pandemic
localised lockdowns dampen activity and pent-up levels. But consumption of services hasn’t
demand fades. The progression of Covid-19 and picked up to a similar degree and is unlikely to
the prospects for a vaccine remain the key drivers any time soon as a recent spike in virus cases,
of economic activity globally. most notably in Spain, keeps households
reluctant to engage in face-to-face activities. A
• GDP in the United States declined at a pace
potential end to employment support schemes,
of –32.9% on an annualised basis in the second
with Spain’s scheduled to expire first at the end
quarter, near the more optimistic end of our
of September, bears watching. We continue to
–30% to –40% estimate. Vanguard expects
foresee full-year contraction around –10% for
a more gradual recovery than consensus
the euro area economy.
estimates amid continued virus transmission
and consumer reluctance to engage in face-to- • The economy in the United Kingdom
face activity. We continue to foresee a 2020 contracted by –20.4% in the second quarter
US economic contraction ranging from –7% compared with the first quarter. The effects
to –9%. This outlook assumes that regional have been most pronounced in those industries
virus outbreaks and associated restrictions that are most exposed to public health
on economic activity will occur but that restrictions and the effects of social distancing.
nationwide lockdowns won’t be required. Vanguard expects a slower recovery for the
United Kingdom than we do for the euro
Note: The points in this document represent the house view of the Investment Strategy Group’s (ISG’s) global economics team and other experts as of 18 August 2020.
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.area given the greater weight of face-to-face • The US Federal Reserve left the target range
activities in the UK economy. Although most for its federal funds rate at 0% to 0.25% on 29
supply has come back online, we expect the July and said it would keep it there until it was
demand shock to persist as households remain “confident that the economy has weathered
reluctant to engage in highly social activities recent events”. In its most recent summary of
amid a recent uptick in new virus cases. economic projections, issued in June, the Fed
suggested it would leave its target range intact
• China is ahead of most of the world in the
until 2022.
timetable of its recovery, having been affected
by the virus and containment efforts first. Its • The European Central Bank left its monetary
GDP grew by a greater-than-expected 11.5% policy unchanged at its July meeting, keeping
in the second quarter compared with the first the interest rate on its deposit facility at
quarter, having contracted by –10% in the first –0.50%, continuing monthly asset purchases
quarter. Compared with a year earlier, China’s of €20 billion as long as needed to reinforce
GDP grew by 3.2%, having contracted by its accommodative stance, and maintaining
–6.8% in the first quarter. Preliminary reports the size of the Pandemic Emergency
suggest that the recovery moderated somewhat Purchase Programme at €1.35 trillion until
in July, as Yangtze River floods interrupted June 2021. ECB President Christine Lagarde
infrastructure construction and regional virus acknowledged that the pace of asset
containment efforts weighed on consumption. purchases had slowed as economic activity
The moderating trend in July is consistent with has increased, but she emphasised that she
our view that sequential momentum will slow expects the full programme to be used except
in the second half as catch-up production fades, in a “significant upside scenario” that she
medical and work-from-home exports peak, views as “quite unlikely”.
and domestic financial conditions tighten as
• The Bank of England maintained its bank
the People’s Bank of China prioritises financial
rate at 0.1% at its August Monetary Policy
stability amid rising asset prices. Vanguard
Committee (MPC) meeting and reiterated
continues to foresee full-year growth for China
that the £300 billion of extra asset purchases
in a 1% to 3% range.
announced since March would continue until
• GDP contracted by –7.8% in Japan on a the “turn of the year”. This is consistent with
seasonally adjusted basis in the second prior guidance suggesting a gradual slowing
quarter compared with the first quarter, its of weekly purchases to around £4 billion to £5
third consecutive quarterly decline since billion a week, from the £13.5 billion weekly
the economy first felt the effects of the rate between March and June. The MPC also
consumption tax hike in the fourth quarter of addressed its not-yet-concluded investigation
2019. We continue to foresee Japan’s full-year into the possibility of adopting negative rates,
GDP contracting in a range around –3% to –5%. explaining that it needed to be convinced
that negative rates wouldn’t do more harm
• The International Monetary Fund (IMF) lowered
than good, especially considering potential
its forecast for growth in emerging markets
adverse consequences for the banking sector.
for both 2020 and 2021 on 24 June, owing
These comments, along with the Bank’s
to a rapid intensification of Covid-19 in many
forward guidance and the continuation of
emerging and developing nations. The IMF
asset purchases, reinforce Vanguard’s view
foresees emerging markets contracting by
that negative rates aren’t high on the Bank’s
–3.0% before rebounding to growth of 5.9%
priority list.
in 2021. The outlook for Latin America, under
assault from Covid-19, is particularly pessimistic,
at a contraction of –9.4% for all of 2020 before
Inflation
rebounding to 3.7% in 2021, according to • The consumer price index in the United
the IMF. Emerging markets will be watching States rose 0.6% in July compared with June
developments in US-China relations, which on a seasonally adjusted basis, the same rate
have implications for supply chains and trade- of increase as registered in June, reflecting
related growth. increased demand as pandemic restrictions
eased. The rise was 1.0% compared with
Monetary policy July 2019, higher than the 0.6% annual rise
registered in June. Core inflation, which strips
Given our expectation for a slow recovery in
out volatile food and energy prices, rose 0.6%
demand amid pandemic containment efforts,
in July – its largest monthly increase since
Vanguard continues to expect monetary policy to
1991 –and to 1.6% compared with a year
remain loose throughout 2020 and well into 2021,
earlier. Vanguard doesn’t see the higher-than-
with the risks skewed towards further easing.
expected numbers to be part of a meaningful
firming trend. We believe the modest uptickis consistent with our medium-term view that furlough and other job support schemes have
inflation could trend gradually higher as states successfully contained unemployment so far,
reopen and activities resume but remain below but we’re concerned about the roll-off of these
the Fed’s 2% target range. Risks of disinflation – a programmes, especially in Italy and Spain. A
slowing in the pace of inflation – persist due to the softer labour market would weaken demand
potential for disease outbreaks and containment further in the medium term and increase the risk
efforts to curtail demand. of economic scarring.
• Headline inflation in the euro area rose to 0.4% • The furlough programme in the United Kingdom
in July on an annual basis, higher than the 0.3% has similarly limited the unemployment rate,
registered in June. Core inflation – excluding but we expect the rate to rise above 7% in the
energy, food, alcohol and tobacco – registered fourth quarter as the scheme unwinds. We
at 1.2%. Vanguard expects headline and core don’t anticipate an extension to the scheme
inflation to converge only by the second quarter unless another national lockdown is initiated.
of 2021, and for upward pressure on core inflation Another wave of unemployment could follow in
to materialise as demand recovers. But we find it January 2021 as an incentive to retain furloughed
difficult to see a scenario where the core rate rises workers expires. We foresee a peak in the UK
close to the European Central Bank’s 2% target unemployment rate of over 8% in the first half of
over the next 12 months. 2021. The unemployment rate under the official
International Labour Organization measure stood
• Headline inflation in the United Kingdom rose
at 3.9% in June, no higher than it had been in
1.0% in July from a year earlier, compared with
February.
a 0.6% rise in June. Vanguard expects inflation
to slow to close to zero in the fourth quarter as a
consequence of a temporary value-added tax cut in
Trade
the hospitality and accommodation sectors. Over Data from national sources confirms one of the
the medium term, we expect demand to recover steepest drops in global trade ever recorded
more slowly than supply and the labour market occurred in the May-June period, amid Covid-19
to weaken, exerting disinflationary pressures on lockdowns. China, buoyed by exports of virus-
both the core and headline rates of inflation. With related products such as pharmaceuticals, personal
the risk of tariff imposition following Brexit, in protective equipment and home-office supplies, was
addition to significant monetary and fiscal stimulus, a notable exception. Vanguard believes that trade
we foresee inflation rising toward the Bank of reached an inflection point in the middle of the year
England’s 2% target within the next two years. and has bounced off lows, with our index of leading
indicators increasing for a third consecutive month.
Employment
Brexit
• The United States continued to add jobs in July,
albeit at a slower pace than in the preceding two The European Union has marked its calendar.
months, enabling the unemployment rate to fall to October 15 is the day it considers it will need to
10.2%. Overall, we expect a gradual recovery in have approved a trade agreement with the United
the number of employed people and a reduction Kingdom in order for the European Parliament to
in the unemployment rate by year’s end to a range have sufficient time to ratify the deal and for it
of 8% to 10%. Though the July unemployment to take effect by 1 January 2021. The latter date
rate is near that range now, Vanguard expects that marks the end of the year-long transition during
some three million people who were displaced which the UK’s relationship with the European
by the pandemic and left the workforce will Union has proceeded unchanged following the
gradually re-enter it, putting upward pressure on UK’s formal exit from the European Union on
the unemployment rate as they look for work. 31 January, 2020. For the current negotiation and
This could offset to some extent the downward ratification time frame to be feasible, a trade deal
pressure from job gains. Vanguard will particularly would realistically need to be reached by the end of
watch the percentages of temporarily unemployed September to allow a formal treaty to be prepared.
individuals compared with permanently
unemployed in the months ahead as an insight into Asset class return outlook
the strength of economic recovery. Vanguard has updated its 10-year annualized
• Unemployment in the euro area rose to 7.8% in outlook for broad asset class returns through
June from a revised 7.7% in May. For the whole the most recent running of the Vanguard Capital
second quarter, the number of employed people Markets Model® (VCMM), our proprietary financial
decreased by 2.8% compared with the previous simulation tool, based on data as of 30 June 2020.
quarter, the sharpest decline observed since the The probabilistic return assumptions depend on
data series started in 1995. Vanguard believes that market conditions at the time of the running of the
VCMM and, as such, can change with each running
over time.Outlook ranges may differ from what was presented Please note that the figures are based on a 1-point
in the July economic and market update. Those range around the 50th percentile of the distribution
ranges reflected only a preliminary running of the of return outcomes for equities and a 0.5-point
VCMM as of 30 June for a limited set of sub-asset range around the 50th percentile for fixed income.
classes, and were rounded. Numbers in circles reflect median volatility.
Median projected Ten-year annualised
volatility (%) nominal return projections
Euro area equities* 25.2 5.2–7.2%
Global ex-euro equities area 3.7–5.7%
(unhedged)*
19.6
Euro area aggregate bonds* 1.8 -0.2–0.8%
Global ex-euro area bonds -0.1–0.9%
(hedged)*
3.2
UK equities† 19.4 5.9–7.9%
Global ex-UK equities 4.8–6.8%
(unhedged)†
19.2
UK aggregate bonds† 5.7 0.1–1.1%
Global ex-UK bonds 0.2–1.2%
(hedged)†
2.7
Note: * return projections are calculated for Euro investors. † return projections are calculated for British pound investors.
Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.Important information 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 June 30, 2020. 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 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. Connect with Vanguard > global.vanguard.com ® 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. 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, this document is directed at professional investors and should not be distributed to, or relied upon by retail investors. The material contained in this document 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 Vanguard Research anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or © 2020 Vanguard Asset solicitation is not qualified to do so. The information in this document does not constitute legal, tax, or Management Limited investment advice. You must not, therefore, rely on the content of this document when making any investment © 2020 Vanguard Investments decisions. The material contained in this document is for educational purposes only and is not a Switzerland GmbH. recommendation or solicitation to buy or sell investments. All rights reserved Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority. Issued by Vanguard Investments Switzerland GmbH. FAVEMOBF 0820/120
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