July 20, 2021 | Vanguard Perspective

A midyear update on our economic and market outlook

The outlook for the global economy continues to hinge on health outcomes. In our annual economic and market outlook published at the end of 2020, Vanguard economists expected that the path to recovery would be uneven and varied across industries and countries, even once effective vaccines for COVID-19 became available.

Fast forward half a year. The pandemic is still far from over as new virus variants surface where vaccination rates lag and as the human toll continues to mount, especially in less developed economies. Yet macroeconomic indicators signal that the global economy is rebounding faster than many had expected from its sharpest contraction in modern history. That rebound is reflected in our current full-year GDP growth forecasts, which remain roughly in line with our optimistic projections at the start of 2021. In some places, we've upgraded our forecasts; in others, we've downgraded them. 

Countries that have contained the virus more successfully, whether through vaccinations, lockdowns, or both, have tended to see their economies hold up better, said Andrew Patterson, senior international economist in Vanguard's Investment Strategy Group. As economies open up, demand—supported in many countries by government spending—will promote growth and, by extension, underlie our outlooks for inflation and monetary policy. Given Vanguard’s focus on return expectations over the long term, revisions to our investment return outlooks remain a function of valuations and risks informed by current and expected future macroeconomic conditions and policy.

Vaccination rates and fiscal support are driving the economic recovery

The extraordinary global response to the pandemic has set the stage for a strong economic recovery. Vaccines were developed, tested, and made available faster than many anticipated. By our estimates, shown in the chart below, about 75% of the world's population will have received at least one vaccine dose by the end of 2021, putting herd immunity in the largest economies within reach.1 The reaction of governments and central banks has also been impressive, as many moved swiftly to provide unprecedented levels of fiscal and monetary support.

Percentage of population with at least one vaccine dose

Line chart shows the percentage of certain populations who have received at least one COVID-19 vaccine dose. It shows actual percentages from December 2020 through June 2021 and projections thereafter through December 2021. The chart shows that more than 50% of people in the United Kingdom, the United States, and Canada had at least one dose by June 2021, compared with less than 40% of people in China, the European Union, Mexico, Australia, and the world overall. Our projections show that in all regions at least 60% of individuals will have had at least one dose by the end of 2021. No projections are shown for Canada or Mexico.

Notes: Levels that constitute herd immunity will vary by region, depending on vaccine efficacy. Higher vaccination rates generally permit greater economic activity.

Sources: Vanguard projections, based on data from Our World in Data, the University of Oxford, and the Australian federal government as of June 1, 2021. No projections are available for Canada and Mexico.

At the same time, the chart shows that vaccination rates have differed significantly by country and region. So have outcomes from policymakers' efforts to blunt COVID-19's economic impact. Both factors are likely to contribute to the recovery’s continued unevenness for the rest of this year and beyond.

Our full-year GDP growth forecasts still reflect how far we’ve had to climb back to approach pre-pandemic growth. In the United States, for example, where positive health care developments and strong fiscal support are driving growth, we’ve raised our full-year forecast to at least 7%. Vaccination programs accelerated after a somewhat slow start, paving the way for the reopening of segments of the economy that depend heavily on face-to-face interaction. Government programs, including enhanced unemployment benefits and stimulus checks delivered directly to lower-income earners, have supported consumer spending.

For the euro area, our forecast for 2021 growth of around 5% is unchanged. A halting start to vaccination rollouts and repeated lockdowns tipped the bloc back into recession early this year, but supportive policy, an easing of travel restrictions, and consumption that remains 10% below its pre-pandemic trend could underpin a strong bounce-back.

For China, we have lowered our 2021 forecast to around 8.5%. The country has largely contained the pandemic and was the first to return to its pre-COVID GDP level, but consumption is taking time to normalize amid slow vaccination rollouts and sporadic virus outbreaks. Domestic consumption may continue to lag even as vaccinations ramp up, but exports have boosted China's economy.

For emerging markets, we have raised our forecast for 2021 to above 6%. A resurgence of the virus, particularly in emerging Asia, weighed on growth in the first half of this year, but growth should accelerate as vaccination efforts advance.

How faster growth could affect inflation and monetary policy

Various factors are fanning concerns about higher inflation, including the stronger-than-expected rebound in global growth, extraordinary and unprecedented monetary and fiscal stimulus, and a jump in demand for goods and services as economies reopen and supply gradually comes back online. Although we expect the effects to be largely transitory, our outlook is for a modest but eventually persistent increase in inflation.

Improving economies and somewhat higher inflation are, in turn, spurring questions about monetary policy. Some central banks have already begun slowing the pace of asset purchases put in place at the start of the pandemic, and others are contemplating doing so. Such moves constitute a gradual removal of accommodative monetary policy. We nevertheless expect that initial increases in central bank short-term rates won’t occur broadly before 2023.

U.S. inflation risks are higher than those in other countries given some supply-and-demand imbalances. Diminished supply of goods, including new and used cars, and of labor, amid demand rebounds in some sectors, might take time to unwind. Our baseline scenario, shown in the chart below, is that core inflation (which excludes volatile food and energy prices) will persist above the Federal Reserve’s 2% target in the second half of 2021 before moderating in 2022.

There is a risk, however, that significantly more fiscal spending on the order of $2 trillion to $3 trillion—our “go big” scenario in the chart below—could lead inflation to significantly overshoot the Fed's target later this year and into 2022. Such a development could affect inflation psychology, in which higher expected inflation can lead to higher actual inflation.

Inflation: Up, up … but not away in 2021

Line chart shows actual monthly year-over-year percentage changes in U.S. core CPI from January 1995 through May 2021. It also shows projected monthly year-over-year percentage changes under two scenarios from June 2021 through December 2022. The first scenario is Vanguard’s baseline forecast for U.S. core CPI, and the second is Vanguard’s “go big” upside forecast for U.S. core CPI. A horizontal band shows the legacy inflation target range of 1.75% to 2.25% that the Federal Reserve abandoned in August 2020 in favor of a policy of average inflation targeting, which allows inflation to surpass that level for some time. The chart shows that actual U.S. core CPI spiked to almost 3% in April 2021. The projection of Vanguard’s baseline forecast scenario shows U.S. core CPI exceeding 3% at times in 2021 but falling below that in 2022. The projection of Vanguard’s “go big” upside forecast scenario shows U.S. core CPI remaining consistently above 3% in 2021 before moderating in 2022.

Sources: Vanguard, based on data from January 1995 through April 2021 from the U.S. Bureau of Labor Statistics.

With its 2020 adoption of “average inflation targeting,” which makes 2% a longer-term goal rather than an upper limit, the Fed may be more comfortable letting inflation run reasonably above 2% for some time. We foresee accommodative policy persisting for the rest of 2021, though plans for reducing the pace of asset purchases are likely to be disclosed in the second half. We currently don’t foresee conditions meeting the Fed’s rate-hike criteria of price stability and maximum sustainable employment until the second half of 2023.

Headline inflation, as shown in the chart below, is likely to follow similar paths in the euro area and the United Kingdom. Euro-area energy prices are likely to push headline inflation above 2% in the second half of 2021, but underlying price pressures remain subdued. We foresee core inflation rising to a range of 1% to 1.5% by year-end, slightly higher than our view when 2021 began. The European Central Bank is likely to keep interest rates on hold at least through 2022, even as the economy improves, though it will probably slow its pace of asset purchases in the near term.

Headline inflation in the euro area and U.K. is likely to moderate in 2022

Line chart shows actual monthly year-over-year percentage changes in headline CPI from January 2019 through May 2021 for the euro area and the UK. For both regions, it also shows monthly year-over-year percentage change projections in headline CPI from June 2021 through December 2022. The actual changes for both regions show that headline CPI climbed to above 2% in May 2021. The projections show headline CPI continuing to rise in both regions toward the end of 2021 and then moderating in 2022.

Sources: Vanguard, based on data from January 2019 through May 2021 from the UK Office for National Statistics and Eurostat.

We continue to foresee core inflation in China of around 1.5% for 2021, well below the People's Bank of China's 3% target. Although producer prices have climbed, we expect pass-through effects to remain limited, especially amid modest consumer demand. We expect monetary policy to continue to normalize, but only gradually as economic growth remains uneven.

Inflation in emerging markets has been higher than expected. A disinflationary trend in parts of Asia has disappeared, and inflation in other regions has largely risen above its pre-pandemic pace as higher borrowing costs in developed markets spill over. Inflation dynamics and rising U.S. interest rates have constrained central banks' accommodative bias even as economic growth remains below potential. Recent rate hikes in Brazil, Russia, and Turkey amid rising inflation demonstrate the challenge.

Where our 10-year return forecasts stand

Starting valuations matter. Global stocks this year have continued to rally from pandemic lows, and that will make further gains harder to come by. In fact, our 10-year annualized return forecasts for some developed markets are nearly 2 percentage points lower than they were at the end of 2020.

The news is better for bond investors. Because we expect bond portfolios of all types and maturities to earn returns close to their current yield levels, the recent increase in market interest rates has led us to raise our 10-year annualized return forecasts by a half to a full percentage point for a number of markets.

Our forecasts, in local currencies, are derived from a May 31, 2021, 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:

U.S. stocks: 2.4% to 4.4%; Ex-U.S. stocks: 5.2% to 7.2%.

U.S. bonds: 1.4% to 2.4%; Ex-U.S. bonds: 1.3% to 2.3% when hedged in U.S. dollars.

Euro-area stocks: 2.9% to 4.9%; Ex-euro-area stocks: 1.6% to 3.6%.

Euro-area bonds: –0.5% to 0.5%; Ex-euro-area bonds: –0.5% to 0.5% when hedged in euros.

Chinese stocks: 5.1% to 7.1%; Ex-China stocks: 3.6% to 5.6%.

Chinese bonds: 2.8% to 3.8%.


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, 2021. Results from the model may vary with each use and over time. For more information, please see important information below.

A final word about bonds and portfolios

Even with our upward revisions, returns from bonds in most markets are likely to be modest. We nonetheless still see their primary role in a portfolio as providing diversification from riskier assets rather than generating returns.

Keep in mind that return forecasts change in response to evolving assessments of economic and market conditions, but that doesn't mean your investment plan should change. In fact, long-term investors often have the best chance of investment success by staying the course if their investment plan is diversified across asset classes, sectors, and regions and is in line with their investment goals and tolerance for risk.

In addition, for clients concerned about the impact of shifting market conditions on their retirement portfolios, consider sharing this recent piece that explains how a dynamic spending plan can have a dampening effect on portfolio volatility.


1 Herd immunity is the point at which a virus’ spread becomes harder because numbers of vaccinated and already-infected people have reached a certain threshold.


Important information

All investing is subject to risk, including possible loss of principal. Diversification does not ensure a profit or protect against a loss. 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 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.

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, 2021. 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 Barclays U.S. Aggregate Bond Index.
Global ex-U.S. bonds: Bloomberg Barclays 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 Barclays Euro-Aggregate Bond Index.
Global ex-euro-area bonds: Bloomberg Barclays Global Aggregate ex Euro Index.

U.K. equities: Bloomberg Barclays Equity Gilt Study from 1900 through 1964; Thomson Reuters Datastream UK Market Index from 1965 through 1969; MSCI UK Index thereafter.
Global ex-U.K. 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.
U.K. aggregate bonds: Bloomberg Barclays Sterling Aggregate Bond Index.
Global ex-U.K. 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 Barclays US Aggregate Bond Index from 1976 to 1990; Bloomberg Barclays Global Aggregate Index from 1990 through 2001; Bloomberg Barclays 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 Barclays Australian Aggregate Bond Index.
Global ex-Australia bonds: Bloomberg Barclays 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 Barclays Canadian Issues 300MM Index.
Global ex-Canada bonds: Bloomberg Barclays 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 Barclays Global Aggregate Index.