Vanguard economic and market outlook for 2023

Vanguard research December 2022 Vanguard economic and market outlook for 2023: Beating back inflation ● Generationally high inflation has led to a marked slowing in global economic activity. Rapid monetary tightening aimed at bringing down inflation will ultimately succeed, but at a cost of a global recession in 2023. ● Current and expected conditions are like those that have signaled past global recessions. Significantly deteriorated financial conditions, increased policy rates, energy concerns, and declining trade volumes indicate the global economy will likely enter a recession in the coming year. Job losses should be most concentrated in the technology and real estate sectors, which were among the strongest beneficiaries of the zero-rate environment. ● Inflation continued to trend higher in 2022 across most economies as supply chains had yet to fully recover from pandemic-related distortions and as demand was buoyed by strong household and business balance sheets. Inflation has likely already peaked in most markets, but reducing price pressures tied to labor markets and wage growth will take longer. As such, central banks may reasonably achieve their 2% inflation targets only in 2024 or 2025. ● Consistent with our investment outlook for 2022, which focused on the need for higher short-term interest rates, central banks will continue their aggressive tightening cycle into early 2023 before pausing as inflation falls and job losses mount. Importantly, we see most central banks reluctant to cut rates in 2023 given the need to cool wage growth. ● Although rising interest rates have created near-term pain for investors, higher starting rates have raised our return expectations for both U.S. and international bonds, which we now expect to return roughly 4%–5% over the next decade. ● Equity markets have yet to drop materially below their fair-value range, which they have historically done during recessions. Longer term, however, our global equity outlook is improving because of lower valuations and higher interest rates. Our return expectations are 2.25 percentage points higher than last year. From a U.S. dollar investor’s perspective, our Vanguard Capital Markets Model projects higher 10-year annualized returns for non-U.S. developed markets (7.2%–9.2%) and emerging markets (7%–9%) than for U.S. markets (4.7%–6.7%).