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Risk of recession is rising across economies

A lot has changed since Vanguard published its economic and market outlook for 2022, Striking a Better Balance . At the start of the year, we expected global economies to continue to recover from the effects of the COVID-19 pandemic but at a more modest pace than in 2021. While that holds true, the pace of change in macroeconomic fundamentals such as inflation, growth, and monetary policy has failed to live up to expectations. 

Labor and supply-chain constraints were already fueling inflation before the year began, but Russia’s invasion of Ukraine and China’s zero-COVID policy exacerbated the situation. Central banks have been forced to play catchup in the fight against inflation, ratcheting up interest rates more rapidly and possibly higher than previously expected. But those actions risk cooling economies to the point that they enter recession.

“Global economic growth will likely stay positive this year, but some economies are flirting with recession, if not this year, then in 2023,” said Andrew Patterson, Vanguard senior international economist. 

Compared with the start of the year, Vanguard has downgraded its 2022 GDP growth forecasts for all the major regions, increased its inflation forecasts, and become more hawkish about monetary policy.

Inflation, policy elevate the risk of recession

In the United States, inflation has reached 40-year highs, eroding consumers’ purchasing power and driving the Federal Reserve to aggressively raise interest rates. We expect the equivalent of 12 to 14 rate hikes of 25 basis points for the full year, with the target federal funds rates landing in the 3.25%–3.75% range by year-end. We expect a terminal rate of at least 4% in 2023—higher than what we consider to be the neutral rate (2.5%) and above what’s currently being priced into the market. (The neutral rate is the theoretical rate at which monetary policy neither stimulates nor restricts an economy.)

We have downgraded expected U.S. GDP growth from about 3.5% at the start of the year to about 1.5%. The factors that led to our downgrade will likely continue through 2022—namely, tightening financial conditions, wages not keeping up with inflation, and lack of demand for U.S. exports. Labor market trends are likely to keep downward pressure on the unemployment rate through year-end, though increases in 2023 are likely as the impacts of Fed policy and slowing demand take hold. We assess the probability of recession at about 25% over the next 12 months and 65% over 24 months. We believe that a period of high inflation and stagnating growth is more likely than an economic “soft landing” of growth and unemployment rates around or above longer-term equilibrium levels (about 2% for growth and 4% for unemployment). 


As a net energy exporter, Canada is in a better situation than most countries, getting an economic boost from higher oil and gas prices. But higher prices reduce consumers’ purchasing power, and the Bank of Canada is likely to front-load increases to its overnight rate above the neutral rate (~2.5%) if needed to curb inflation. Unemployment may rise in the second half of the year, but given high job vacancies and accelerating wage growth, the labor market will likely stay healthy despite rate hikes. Population growth supports a real estate sector under pressure from rising interest rates. We’ve downgraded our economic growth forecast from 5% at the start of the year to roughly 4%.


Higher prices benefit Mexico as an energy and agriculture exporter, but inflation still weighs down spending and growth. Headline inflation has shown signs of moderation, but core inflation has risen for seven consecutive months, indicating broadening price pressures across the economy. The Bank of Mexico has raised its target policy rate to 7.75% and is not done yet. Despite this, the unemployment rate has fallen to a low 3% and may rise by only half a percentage point by year-end. Our full-year economic growth forecast remains little changed at about 2%.


In the euro area, headline inflation driven by high energy prices may spike to near 10% in the third quarter. Inflation has become widespread, spurring the European Central Bank into what it expects will be a “sustained path” of interest rate increases. In September, rates will likely be out of negative territory for the first time in a decade. We forecast economic growth to be about 2% to 3% for the full year. However, Europe’s dependence on Russian natural gas and the challenges of managing monetary policy for 19 countries put the euro area at a higher risk of recession than the United States in the next 12 months. A complete cutoff from Russian gas would likely lead to rationing and recession.

United Kingdom

In the United Kingdom, energy prices will likely drive the headline inflation rate to roughly 10% late in the year. We expect the Bank of England to raise the bank rate by an additional 1.25 percentage points over the next 12 months to reach our estimate of a 2.5% neutral rate. The bank has signaled that it’s prepared to enact larger than 25-basis-point rate hikes, depending on the economic and inflation outlook. 

Even with rising inflation and a slowing economy, the labor market will likely stay strong, given record job vacancies and unemployment near a 50-year low. But a drop in real wages, combined with diminished consumer and business confidence and tightening financial conditions, could push the United Kingdom into recession. Vanguard sees the probability of recession at about 50% over the next 12 months. For 2022, we’ve downgraded our 5.5% forecast at the start of the year to 3.5%–4%.


China will fall far short of policymakers’ growth target of about 5.5%, given that it’s a challenge to achieve all three of their goals: the growth target, financial stability, and a zero-COVID policy. (The latter affects not just China’s economy, but the global economy as well.) We believe the actual 2022 GDP growth rate will be just above 3%, far below China’s pace for many years. Given China’s zero-COVID policy, additional outbreaks resulting in renewed lockdowns could further detract from growth.


Australia’s status as a commodities exporter has partly insulated it from the some of the economic woes elsewhere, but global factors and rising inflation still have an impact. Broad-based and persistent inflation has the Reserve Bank of Australia on course to raise its target rate by more than 2 percentage points in 2022. The labor market is robust, with the unemployment rate falling to a historical low. It should stabilize as growth slows, but upward pressure on wages is likely to persist for a while. A recession isn’t likely in Australia unless major developed markets fall into recession first. We’ve reduced our growth forecast by a percentage point from the start of the year, to 3%–3.5%. 

Emerging Markets

We recently downgraded our forecast for full-year 2022 growth in emerging markets, from about 5.5% at the start of the year to about 3%. Emerging markets continue to face headwinds from slowing growth in the United States, the euro area, and China, as well as from developed markets’ central bank tightening and from domestic and global inflation. Although higher commodities prices do benefit some emerging economies, they’re a negative in the aggregate.


Probability of recession for select regions

Source: Vanguard forecasts as of June 30, 2022.


Vanguard’s forecasts for year-end 2022

Notes: Forecasts evolve with new data, and our views will inevitably change. Growth is the change in annualized GDP year over year. Inflation is the headline consumer price index, which includes the volatile food and energy sectors. Monetary policy is our year-end projection for the central bank’s short-term interest rate target.

Source: Vanguard forecasts as of June 30, 2022.


Expected 10-year asset class returns have risen

Stock and bond markets have been hit hard so far in 2022. But there is an upside to down markets: Because of lower current equity valuations and higher interest rates, our model suggests higher expected long-term returns.

Our 10-year annualized return forecasts for equity markets are largely 1 percentage point higher than at the end of 2021. In many regions, our bond return forecasts are 1.5 percentage points higher. Rising yields may detract from bonds’ current prices, but that means higher returns in the future as interest payments are reinvested in higher-interest bonds.

Our forecasts are derived from a May 31, 2022, running of the Vanguard Capital Markets Model®. The figures are based on a 1-point range around the 50th percentile of the distribution of return outcomes for equities and a 0.5-point range around the 50th percentile for bonds.

Here are our current 10-year annualized return forecasts. Forecasts are from the perspectives of local investors in local currencies:

U.S. stocks: 3.4% to 5.4%; ex-U.S. stocks: 6.1% to 8.1%.

U.S. bonds: 3% to 4%; ex-U.S. bonds: 2.9% to 3.9% when hedged in U.S. dollars.

Euro-area stocks: 3.5% to 5.5%; ex-euro-area stocks: 2.4% to 4.4%.

Euro-area bonds: 1% to 2%; ex-euro-area bonds: 1% to 2% when hedged in euros.

UK stocks: 3.8% to 5.8%; ex-UK stocks: 3.6% to 5.6%.

UK bonds: 2.1% to 3.1%; ex-UK bonds: 2.1% to 3.1% when hedged in British pounds.

Chinese stocks: 6.9% to 8.9%; ex-China stocks: 4.4% to 6.4%.

Chinese bonds: 2.4% to 3.4%.

Australian stocks: 3.5% to 5.5%; ex-Australia stocks: 4.8% to 6.8%.

Australian bonds: 3.1% to 4.1%; ex-Australia bonds: 3.3% to 4.3% when hedged in Australian dollars.

Canadian stocks: 3.5% to 5.5%; ex-Canada stocks: 4.4% to 6.4%.

Canadian bonds: 3% to 4%; ex-Canada bonds: 2.7% to 3.7% when hedged in Canadian dollars.

Mexican stocks: 6% to 8%; U.S. stocks: 7.5% to 9.5%; global ex-U.S. developed market stocks: 10.3% to 12.3%.

Mexican bonds: 10% to 11%; ex-Mexico bonds: 8.9% to 9.9% when hedged in Mexican pesos.


IMPORTANT: The projections and other information generated by the 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. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modeled asset class. Simulations as of May 31, 2022. Results from the model may vary with each use and over time. For more information, please see the Important information section.

Important information

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss in a declining market. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

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.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

About the Vanguard Capital Markets Model:

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 Investment Strategy Group. 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. 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.

Indexes used in Vanguard Capital Markets Model simulations

The long-term returns of our hypothetical portfolios are based on data for the appropriate market indexes through May 31, 2022. We chose these benchmarks to provide the most complete history possible, and we apportioned the global allocations to align with Vanguard’s guidance in constructing diversified portfolios. Asset classes and their representative forecast indexes are as follows:


U.S. equities: MSCI US Broad Market Index.

Global ex-U.S. equities: MSCI All Country World ex USA Index.

U.S. aggregate bonds: Bloomberg U.S. Aggregate Bond Index.

Global ex-U.S. bonds: Bloomberg Global Aggregate ex-USD Index.

Euro-area equities: MSCI European Economic and Monetary Union (EMU) Index.

Global ex-euro-area equities: MSCI AC World ex EMU Index.

Euro-area aggregate bonds: Bloomberg Euro-Aggregate Bond Index.

Global ex-euro-area bonds: Bloomberg Global Aggregate ex Euro Index.

UK equities: Bloomberg Equity Gilt Study from 1900 through 1964; Thomson Reuters Datastream UK Market Index from 1965 through 1969; MSCI UK Index thereafter. 

Global ex-UK equities: Standard & Poor’s 90 Index from January 1926 through March 4, 1957; S&P 500 Index from March 4, 1957, through 1969; MSCI World ex UK Index from 1970 through 1987; MSCI AC World Index ex UK thereafter.

UK aggregate bonds: Bloomberg Sterling Aggregate Bond Index.

Global ex-UK bonds: S&P High Grade Corporate Index from 1926 through 1968; Citigroup High Grade Index from 1969 through 1972; Lehman Brothers US Long Credit AA Index from 1973 through 1975; Bloomberg US Aggregate Bond Index from 1976 to 1990; Bloomberg Global Aggregate Index from 1990 through 2001; Bloomberg Global Aggregate ex GBP Index thereafter.

Chinese equities: MSCI China A Onshore Index.

Global equities ex-China: MSCI All Country World ex China Index.

Chinese aggregate bonds: ChinaBond Aggregate Index.

Australian equities: MSCI Australia Index.

Global ex-Australia equities: MSCI All Country World ex-Australia Index.

Australian bonds: Bloomberg Australian Aggregate Bond Index.

Global ex-Australia bonds: Bloomberg Global Aggregate ex-AUS Bond Index.

Canadian equities: MSCI Canada Total Return Index.

Global ex-Canada equities: MSCI All Country World Index ex-Canada in CAD.

Canadian aggregate bonds: Bloomberg Canadian Issues 300MM Index.

Global ex-Canada bonds: Bloomberg Global Aggregate ex-Canada Index (CAD Hedged).

Mexican equities: MSCI Mexico Index.

Global ex-U.S. developed-market equities: MSCI World ex US Index.

Mexican sovereign bonds: S&P/BMV Sovereign MBONOS Bond Index.

Global bonds ex-Mexico: Bloomberg Global Aggregate Index. 

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