Vanguard economic and market update
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OC TOB ER 2022
Vanguard economic
and market update
The points below represent the house view of the Vanguard Investment Strategy
Group’s (ISG’s) global economics and markets team as at 19 October 2022, on several
current macroeconomic and market topics.
Key highlights:
y US interest rates expected to peak at 4.5% by the y UK economy expected to contract by up to 0.5%
end of March 2023. in 2023, rates to peak at 5%.
y Euro-zone inflation seen reaching 11% in the y 10-year annualised outlook for returns raised for
fourth quarter. both equities and bonds
Economic growth European nations are adapting to the cut-off in natural
gas supplies from Russia, with most achieving their
Vanguard expects a solidly positive number
storage targets ahead of time through alternative
for third-quarter GDP in the United States,
sources. But we remain cautious on the outlook given
perhaps above 2.5%, when the Bureau
forecasts for a colder, drier and less windy than usual
of Economic Analysis (BEA) reports its first
early winter. We project that consumption will have
estimate on 27 October. We expect that such a number
to be reduced by around 15% this winter. We expect
will overstate the strength of the US economy and will
Germany and Italy—whose economies have had the
be driven in large part by international trade dynamics.
greatest exposure to Russia among the “big four”—to
Core aspects of the economy such as consumer
drive the slowdown. European Union countries have
spending and housing have weakened materially
allocated, on average, around 2.5% of GDP to offset
over the course of 2022. (According to the BEA’s final
a surge in energy prices. Euro area GDP grew 0.8%
reading, the US economy contracted at an annual
on a seasonally adjusted basis in the second quarter
rate of – 0.6% in the second quarter.) We expect that,
compared with the first.
given the monetary policy backdrop and a burgeoning
shortfall in households’ purchasing power amid high
Bond and currency markets soundly rejected a United
inflation, the economy will grow no better than trend
Kingdom government growth plan announced on 23
(around 1.8%) over the next few quarters.
September that included the largest package of tax
cuts in generations. Initial concerns about the proposed
Economic momentum has continued to deteriorate in
budget’s effect on inflation and the government’s
the euro area in recent weeks, and Vanguard continues
financial stability caused bond yields to spike so
to expect a mild recession there this quarter, stretching
quickly that the Bank of England intervened to ward
into the first quarter of 2023. We continue to foresee
off a potential crisis in the pensions market. Vanguard
full-year 2022 economic growth in a range of 2%–3%.
continues to foresee full-year 2022 growth in a range
Our 2023 forecast range is for a contraction of –
of 3% to 4%. For 2023, we anticipate a contraction
0.5% to growth of 0.5%. A closely watched private
of up to 0.5%. GDP contracted by – 0.3% in August
purchasing managers’ index signalled economic
compared with July. Output in consumer-facing
contraction for a third straight month in September,
services fell by – 1.8%, reflecting households’ real-
and a European Commission gauge of consumer
income squeeze.
confidence reached an all-time low.In China, there was the week-long National Congress of increase of at least 100 basis points at its 3 November
the China Communist Party, a major policy gathering meeting. We expect the bank to reach a terminal rate
that takes place every five years and includes the of 5% in the first quarter of 2023, then keep it there for
selection of the party’s secretary general, who also the rest of the year.
serves as president of China. Xi Jinping was named to
the positions for his third consecutive five-year terms The bank voted at its 22 September meeting to begin
at week’s end. the sale of government bonds on its balance sheet
soon after the meeting, but that plan was quickly
High-frequency data had suggested that activity postponed given developments related to release of
started to pick up in late September after much of the government’s “mini budget”. Rather than sell bonds
the quarter until then had been disappointing. We do into the open market, the BOE bought long-dated
foresee a recovery in the fourth quarter, however, as gilts in the open market for a two-week period ended
fiscal and monetary stimulus flow through the economy. 14 October to stem a liquidity crisis in the pension
We foresee growth of 5% in 2023, a downgrade from funds market. The bank said it would delay the start of
our most recent view of 5.5% GDP growth. Still, that quantitative tightening.
would represent growth above our view of China’s
potential 2023 growth of 4.3%, a development that Its goal of reducing its stock of gilts by £80 billion in the
could be concerning depending on its effect on inflation. first 12 months combined with its profile of maturing
(Potential growth is the rate of growth an economy gilts over the period implies that the bank will actively
can sustain in the medium term without generating sell about £10 billion in government bonds per quarter
excess inflation.) through the period (rather than simply letting bonds
roll off its balance sheet by not reinvesting proceeds as
The growth story in emerging markets is one of relative they mature).
resilience compared with that of developed markets.
We foresee economic growth around 3.3% for both We expect the European Central Bank (ECB) to
full-year 2022 and full-year 2023, below consensus announce a 75-basis-point increase in the deposit
but higher than our developed-market views. Growth facility rate when the bank meets on 27 October.
has been slower that it might have been, as rising The bank’s 75-basis-point increase at its September
global interest rates increased debt loads and forced meeting was the largest rate hike in the nearly 25-year
fiscal discipline on emerging markets. Currencies have history of the euro. We continue to foresee the ECB
broadly held their ground as emerging market central raising the deposit facility rate to 2.5% in the first
banks acted sooner and more swiftly to protect them quarter of 2023 and then leaving it at that level for the
ahead of anticipated developed market rate increases rest of the year in a continued effort to return inflation
Emerging Europe remains most at risk of recession toward the bank’s 2% target.
given energy supply challenges there.
The People’s Bank of China kept on an accommodative
tack on 17 October, keeping its one-year medium-
Monetary policy: term lending facility rate at 2.75% for a second
An ever-more-hawkish Federal Reserve has straight month. Vanguard expects policy to remain
led Vanguard to increase its view for the accommodative for the next six months to counter
terminal rate, or end point, for the federal weakness in the real estate sector and the effects of
funds rate target. In our base case, we believe ongoing Covid-19 lockdowns. We expect mortgage and
the Fed will raise the rate to 4.5% by the end of the policy rates to fall slightly, though on the fiscal side we
2023 first quarter, from a current target range of 3% expect more restraint given concerns about financial
to 3.25%. In its last meeting, on 21 September, the Fed stability. As the economy rebounds in 2023, we expect
voted to raise the target for the federal funds rate by policy to switch from accommodative to neutral.
75 basis points, to its current range. We believe the Fed
will keep its target at the terminal rate for some time to Central banks in emerging markets have continued
bring inflation back toward its 2% target. We anticipate to increase policy interest rates in the face of high
a fourth consecutive increase of 75 basis points, inflation, though Vanguard believes that, with inflation
bringing the rate target to a range of 3.75% to 4%. beginning to fall, they may be able to halt and even
reverse some hikes in 2023.
The Bank of England (BOE) raised its bank rate by
50 basis points for a second consecutive meeting on
22 September to a 14-year high of 2.25%, emphasising
that “further, forceful” monetary policy tightening was
needed to bring inflation back to the bank’s 2% target.
The bank rate is now the highest it’s been since 2008
during the global financial crisis. Vanguard expects
the bank’s Monetary Policy Committee will raise the
bank rate at each of its next five meetings, including an
2We have upgraded our forecasts for inflation in China
Inflation for both 2022 and 2023. Higher pork prices are the
Higher-than-expected core inflation in culprit for our view that year-on-year inflation will
two recent reports has led Vanguard exceed 3% on the way to an annual average of 2.3% in
to increase our view of the year-end level 2022. For 2023, we foresee inflation surpassing 4% on
for core inflation in the United States. Core a year-on-year basis and averaging 3.2%, attributable
inflation in the September consumer price index to weakness in China’s currency and the potential for
(CPI) report surprised to the upside for a second further stimulus.
consecutive month, rising by 0.6% from August and
6.6% compared with a year earlier, the highest level Inflation in emerging markets has been more of a goods
since 1982. (Core inflation excludes volatile food and story than a services story, so indications that goods
energy prices and thus reflects broader price pressures price gains are starting to slow is a welcome sign.
in an economy.) CPI including food and energy rose
by 0.6% in September, higher than its 0.1% climb in
August, despite a decline of – 4.7% in energy prices.
Employment
The Federal Reserve’s preferred inflation indicator The unemployment rate fell to 3.5% in
in considering monetary policy, the core personal the United States in September, with the
consumption expenditures (PCE) index, rose by 0.6% in economy adding 263,000 jobs, the Bureau
August, having been flat in July, the Bureau of Economic of Labor Statistics reported on 7 October.
Analysis reported on 30 September. Compared with a Such a degree of job creation at this state of the
year earlier, core PCE reached 4.9%, higher than July’s business cycle signifies a still-strong labour market and
4.7% reading. The reports have led us to increase our allows the Federal Reserve to continue to focus squarely
view of where core PCE will end 2022; we foresee core on inflation in its policymaking. Vanguard believes
PCE around 4.5% at year-end compared with the end that modest declines in job-churning, particularly in
of 2021, higher than our forecast of 4.2% before the higher-wage occupations, should help constrain wage-
release of the September CPI report. growth momentum in coming months. We foresee
the unemployment rate climbing to 4.4% in the fourth
Headline inflation in the euro area reached 9.9% in quarter of 2023.
September, the European Union’s statistical office
confirmed on 19 October. Euro area producer prices The unemployment rate in the euro area remained
were up by 43.3% in August compared with a year steady at a record low of 6.6% in August. We expect the
earlier, slightly higher than expected; energy prices labour market to remain tight even as economic growth
continued their climb, up 116.8% year-on-year. We falters, keeping upward pressure on wages and keeping
expect headline inflation to peak around 11% in the the European Central Bank vigilant.
fourth quarter, higher than our previous view of a
10% peak. We expect inflation to average 8% to 8.5% The unemployment rate in the United Kingdom fell to
in 2022, falling to 5% to 5.5% on average in 2023. 3.5% in the three months through August, the lowest
Although both survey- and market-based inflation since the three months ended February 1974. Inactivity,
expectations remain anchored, the risks of higher rather than employment growth, drove the reduction;
wages feeding into higher inflation are elevated. the number of people economically inactive because
of long-term illness climbed to a record in the period.
Headline inflation in the United Kingdom reached 10.1% Nominal regular wages (excluding bonuses) grew by
in September compared with September 2021, the 5.4% compared with a year earlier, but real (after-
Office for National Statistics reported on 19 October, inflation) wages were down by – 2.4%. Job vacancies
up from a 9.9% year-on-year increase in August. On fell for a fourth consecutive reading in the July-to-
a monthly basis, consumer prices rose by 0.5% in September period but remain near historical highs. Still,
September, higher than a 0.3% rise in August. Food Vanguard sees the decrease as a tentative sign that the
prices, up 14.8% year-on-year, contributed most to the labour market is loosening.
September gains. The gain in headline inflation was
partially offset by falling prices for motor fuels, which
were down 4% in September compared with August.
Core inflation, which excludes volatile food and energy
prices, rose to a cycle high of 6.5% year-on-year. The
government’s recent announcement of an earlier end
to the energy price guarantee scheme presents upside
risks to our inflation outlook. Our current view is that
inflation will average 9% to 9.5% in 2022 and 6.5% to
7% in 2023. We foresee year-on-year headline inflation
falling to around 4.5% by year-end 2023.
3domestic equities, and a 0.4-percentage-point increase
Asset class return outlook for the UK outlook.
improves
Higher sovereign yields have pushed our fixed income
Vanguard’s 10-year annualised outlooks
outlook higher by around a percentage point in the
for equity and fixed income returns have
United States and the euro area and around two
been updated since the September 2022 economic and
percentage points in the United Kingdom since our
market update. The probabilistic return assumptions
30 June outlook.
depend on market conditions at the time of the running
of the Vanguard Capital Markets Model® (VCMM) and,
Our 10-year annualized nominal return projections
as such, can change with each running over time1 .
are as follows. Please note that the figures are based
on a 2-point range around the 50th percentile of the
Developed markets sold off in August and September,
distribution of return outcomes for equities and a
led by the United States and Europe. Valuations
1-point range around the 50th percentile for fixed
contracted as a result, leading to 0.6-percentage-point
income. Numbers in parentheses reflect median volatility.
jumps in our 10-year forecasts for US and euro area
Median projected 10 year annualised
volatility (%) nominal return projections
UK equities 19.2 4.6%-6.6%
Global equities ex-UK (unhedged) 20.5 6.2%-8.2%
UK aggregate bonds 10.4 4.6%-5.6%
Global bonds ex-UK (hedged) 4.8 4.2%-5.2%
4.9%-6.9%
Euro area equities 26.4
Global equities ex-euro area (unhedged) 19.9 3.7%-5.7%
Euro area aggregate bonds 4.4 2.2%-3.2%
Global bonds ex-euro area 4.9 2.1%-3.1%
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 modelled asset class. Simulations are as at 30 September 2022. Results from
the model may vary with each use and over time.
1. ISG updates these numbers quarterly. The projections listed above are based on a partial running of the VCMM based on data
as at 30 September, 2022. Projections based on the full 30 September, 2022, running of the VCMM will be communicated
through the November 2022 economic and market update.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. 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. 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. The information contained in this article 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 anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information in this article does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this article when making any investment decisions. Issued in EEA by Vanguard Group (Ireland) Limited which is regulated in Ireland by the Central Bank of Ireland. Issued in Switzerland by Vanguard Investments Switzerland GmbH. Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority. Connect with Vanguard® © 2022 Vanguard Group (Ireland) Limited. All rights reserved. global.vanguard.com © 2022 Vanguard Investments Switzerland GmbH. All rights reserved. © 2022 Vanguard Asset Management, Limited. All rights reserved. 10/22 120
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