Market perspectives

Vanguard’s outlook for financial markets 

Our 10-year annualized nominal return and volatility forecasts are based on the March 31, 2026, running of the Vanguard Capital Markets Model®.

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 are as of March 31, 2026. Results from the model may vary with each use and over time. For more information, please see the Notes section below.

Source: Vanguard Investment Strategy Group.

Notes: These return assumptions depend on current market conditions and, as such, may change over time. We make our updated forecasts available at least quarterly. 

Oil shock complicates central bank outlooks

The Middle East conflict has thrust global central banks into uncomfortable territory. With oil prices having risen above $100 per barrel since the start of the conflict and expected to remain elevated in the weeks ahead, central banks face a challenge: how to respond when inflation accelerates and growth slows simultaneously.

This is a classic stagflationary shock. Oil price increases hit consumers and businesses almost immediately. Drivers feel it at the pump, the cost of transporting goods rises, and price pressures start to ripple through the economy. Households and companies forced to pay more for energy have less to spend and invest, dragging down demand and pressuring economic growth.

Central banks find themselves pulled in opposite directions. Higher inflation implies tightening, but slowing growth implies easing. This high inflation/low growth combination could weigh on both stock and bond prices.

The calculus of forthcoming policy decisions

The Federal Reserve, European Central Bank (ECB), Bank of England (BoE), and Bank of Japan (BoJ) are all scheduled to announce policy decisions during the week of April 27. Policy statements will no doubt address the energy shock head on.

The ECB, given its reliance on energy imports, is particularly sensitive to the shock. Although it isn’t our baseline case, this sensitivity could lead the ECB to reverse a rate-cut cycle that took the deposit facility rate from 4% to 2% between June 2024 and June 2025. We have already revised our policy outlook for the U.K. and now expect the BoE to maintain the bank rate at 3.75%, not make two quarter-point cuts in 2026 as we had anticipated before the conflict.

Notes: Forecasts are for monetary policy rates at year-end 2026. The Federal Reserve forecast reflects the rounded midpoint of the Fed’s target policy-rate range.

Source: Vanguard.

We assess U.S. monetary policy to be near neutral, where the policy rate would neither stimulate nor restrict economic activity. Although we continue to expect one quarter-point rate cut in 2026 from the current 3.50%–3.75% range, risks have shifted toward a longer period of policy inertia while the conflict plays out.

The effect of suddenly rising energy prices and monetary policy lags

The fundamental challenge is timing. While energy prices can surge overnight, monetary policy works with a lag. By the time higher interest rates soften demand—and, by extension, price increases—inflationary pressures may have already taken hold. The conventional wisdom has been to “look through” such supply shocks. But central banks can’t ignore potential knock-on effects. If higher inflation leads workers to demand higher wages, which feeds into broader price pressures, a temporary shock could become persistent. This is why we expect central banks to err on the side of caution in containing inflation.

The path depends on each central bank’s starting point. With inflation having tracked close to its 2% target in recent months and the labor market stable, the ECB finds itself in a stronger position to deal with an inflationary shock than in February 2022, when inflation was already at 6% and the labor market was tight. That recent history could keep the course of policy finely balanced between hiking and holding, with memories of surging inflation still fresh.

Assuming oil prices in a $90–$100 per barrel range and natural gas averaging €60/megawatt-hour for one to two quarters, we upgraded our 2026 ECB headline inflation forecast to 2.5% while lifting our forecast for core inflation—which excludes volatile food and energy prices—more modestly to 2.1%.

The BoE finds itself in more precarious territory. U.K. inflation has been above its 2% target for roughly five years. Core inflation remained above 3% in February 2026 (the March reading was set to be released April 22). Policymakers are still fighting the last battle even as a new one arrives. We recently downgraded our 2026 U.K. GDP forecast by 0.4 percentage points to 0.6%.

The U.S. central bank has greater flexibility. As a net oil exporter, the U.S. is experiencing a smaller shock overall. Higher oil prices hurt consumers but benefit domestic producers. While sticky inflation and tariff pass-through create complications, the Fed can be patient. The dominant risk is that rates stay higher for longer, not that the Fed will tighten policy.

The BoJ, meanwhile, is navigating upward price and policy normalization rather than disinflation. Higher oil prices and yen weakness support that journey by lifting near-term inflation while strong wage growth underpins the broader normalization narrative.

A reassertion of medium-term market dynamics

Stagflation is likely to be negative for both stocks and bonds. But assuming a limited duration for the Middle East conflict, we expect medium-term market dynamics to reassert themselves. We also continue to emphasize the potential for AI to be transformative and to spread its benefits throughout economies, as outlined in our 2026 annual outlook.

United States: Constructive momentum amid inflation and uncertainty

While the U.S. outlook remains constructive, we have modestly recalibrated our expectations for year-end:

• Downgraded GDP growth by 0.2 percentage points to 2.3%, reflecting firmer energy prices and emerging tariff pass‑through effects.
• Revised unemployment upward by 0.4 percentage points to 4.6%. While the labor market is fundamentally resilient, it’s entering a slower growth phase.
• Increased inflation by 0.2 percentage points to 2.8%. Inflation has resumed its uneven deceleration, though at a slower pace than previously anticipated.
• Retained our expectation for a single Fed policy rate cut in 2026, although the principal risk has shifted toward a longer period of policy inertia.

Region-by-region outlook

Source: Vanguard.

Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2026. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, as of December 2026. For Canada, monetary policy is the Bank of Canada’s year-end target for the overnight rate. For China, monetary policy is the People’s Bank of China’s seven-day reverse repo rate at year-end. For the euro area, monetary policy is the European Central Bank’s deposit facility rate at year-end. For Japan, monetary policy is the Bank of Japan’s year-end target for the overnight rate. For Mexico, monetary policy is the Bank of Mexico’s year-end target for the overnight interbank rate. For the United Kingdom, monetary policy is the Bank of England’s bank rate at year-end. For the United States, monetary policy is the rounded midpoint of the Federal Reserve’s target range for the federal funds rate at year-end.