Market perspectives

Vanguard’s outlook for financial markets

Our 10-year annualized nominal return and volatility forecasts are shown below. They are based on the November 8, 2024, running of the Vanguard Capital Markets Model® (VCMM).

Equity forecasts reflect a 2-point range around the 50th percentile of the distribution of probable outcomes. Fixed income forecasts reflect a 1-point range around the 50th percentile. More extreme returns are possible. 

Notes: These probabilistic return assumptions depend on current market conditions and, as such, may change over time.
Source: Vanguard Investment Strategy Group.

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 modeled asset class. Simulations are as of November 8, 2024. Results from the model may vary with each use and over time. For more information, see the Notes section at the end of this article.

Region-by-region outlook

United States

Our recently published 2025 economic and market outlook details our expectations for continued growth just above 2.00%, core inflation only slowly returning toward the Federal Reserve’s 2.00% target, and the Fed unlikely being able to cut its policy rate target below a 3.75%–4.00% range. But what is the likelihood for alternative scenarios should our baseline outlook not transpire?

"Just as supply-side factors such as increased productivity and plentiful labor drove robust growth amid continued disinflation in 2024, we would expect the next most likely scenarios to be supply-driven,” said Qian Wang, head of the Vanguard Capital Markets Model®.

• Supply-side headwinds. A smaller labor force or reduced productivity could weigh on economic growth and usher in higher prices. Our baseline forecasts account for a degree of such headwinds developing.
• Soft landing. Inflation could return to trend while growth strengthens amid a productivity-induced “soft landing.” The Fed would have more leeway to cut the upper end of its target range to below 4.00%—but not too much, given our assessment that the neutral policy rate is around 3.50% (the neutral rate is a theoretical interest rate that would neither stimulate nor inhibit demand in an economy at full employment).

Less likely, Wang said, are demand-driven scenarios of recession and overheating.

• Recession. A hefty drop-off in demand could slow both growth and inflation significantly, forcing aggressive Fed rate cuts.
• Overheating. Expansionary fiscal policy could lift both growth and inflation, forcing the Fed to consider new rate hikes.

Source: Vanguard

We expect:

• The Fed unlikely being able to cut its policy rate target below a 3.75%-4.00% range. In December, the Fed sent a hawkish message about future rate reductions. Monetary policy could be influenced this year by potential trade and immigration developments.
• Full-year economic growth remaining above 2.00%, a view that accounts for potential changes to trade and immigration policy. Additional 10.00% tariffs on China, if implemented, would fall within that baseline view. However, the initiation of 25.00% tariffs on Canada and Mexico would represent a downside risk to U.S. growth and an upside risk to U.S. inflation.
• Core inflation only slowly returning toward the Fed’s 2.00% target. The January 2025 CPI release, scheduled for February 12, could bring further progress in the inflation fight as some 30 basis points of higher prices will roll out of year-over-year calculations.
• The unemployment rate rising marginally in 2025 to around the mid-4% range. We see recent data as evidence that the labor market has remained consistently strong over the last six months, rather than having softened and then rebounded. Announcements related to immigration to date have been directed at curbing the flow of new immigration, which has already been incorporated into our baseline outlook. 

Euro area

A weak growth outlook and benign inflation should translate into a relatively dovish European Central Bank in 2025.

We expect:         

• The ECB to cut the policy rate by 25 basis points at each of its next five meetings, until the July meeting, and then hold it at 1.75%, just below our estimate of the neutral rate. However, we expect the ECB to monitor two near-term inflation risks: the prospect of rising natural-gas prices and a weakening euro.
• Below-trend economic growth around 0.50% in 2025. The prospect of additional tariffs and related uncertainty would likely weigh on consumer and business sentiment. Continued malaise in the manufacturing sector is likely to weigh on final demand.
• Both headline and core inflation to end 2025 below 2.00% amid weak growth.
• The unemployment rate rising toward 7.00% by the end of 2025, driven by an economic slowdown in Germany and broader growth pressures.

United Kingdom

A recent rise in gilt yields as part of a global sell-off, if sustained, is likely to tighten financial conditions, increasing downside risks to our economic growth forecast.

We expect:

• Quarterly rate cuts in 2025 that would leave the bank rate at a below-consensus 3.75% at year-end. Recent events, taken together, are dovish for the monetary policy outlook. That said, sustained weakness in the pound could heighten inflation risks and challenge the monetary policy view.
• Full-year economic growth of around 1.40%, but risks skew to the downside given tightening financial conditions and early signs of cracks in the labor market.
• Subdued progress on inflation, with the core rate of inflation falling to a 2.40% pace by the end of 2025. Risks skew to the upside given the prospect of global trade tensions and the potential for employers to pass increased national insurance contributions to the consumer.
• The unemployment rate ending 2025 around its current levels, with risks skewed to the upside given recent signs of labor market softening.

China

A strong end to the year helped China achieve its 2024 economic growth target. The headwinds could be stronger in 2025, with a spotlight on the degree of policy support offered and potential U.S. tariffs.

We expect:

• Robust policy support given the prolonged property downturn and fragile consumer sentiment. We expect fiscal policy to take the lead, with the official fiscal deficit limit likely to be increased alongside an increased government bond issuance quota. On the monetary side, we foresee 30 basis points of cuts to the policy seven-day reverse repo rate in 2025 as well as further reductions to banks’ reserve requirement ratios to facilitate fiscal expansion.
• Real GDP growth to slow to around 4.5% in 2025 as the drag from anticipated tariffs will likely outweigh the benefits of policy easing. Excess capacity and subdued domestic demand are conducive to the emergence of a vicious cycle of declining corporate profits, wages, consumption, and prices. Sluggish private investment and credit uptake, along with the continued housing slump, raise fears that China could enter an entrenched deflationary cycle.
• Core inflation of around 1.5% in 2025. We foresee only a modest inflationary thrust from currency depreciation in the face of higher tariffs. Rather, supply-centric policy support has reinforced a negative feedback loop between weak demand and low prices. Both the magnitude and composition of policy stimulus are critical to breaking the cycle.
• The unemployment rate remaining around its current levels in 2025. We believe that structural mismatches in labor supply and demand, particularly among younger workers, may not be easily addressed in the near term and could require additional policy support. 

Emerging markets

We expect the monetary policy easing cycle to broaden, albeit with rates remaining in restrictive territory as a strong U.S. dollar threatens to stoke emerging markets inflation. Trade developments are likely to be in focus throughout 2025.

Inflation has generally remained near or below target in emerging Asia. It is nearing target amid slowing growth in emerging Europe, though rising energy prices present a risk. Inflationary pressures persist in Latin America, however, with services inflation expected to remain elevated, keeping broad inflation gauges above central banks’ targets in 2025.

While the Mexican economy has surged, restrictive interest rates and U.S.-related policy uncertainty make us bearish. We expect growth in a range of 1.25%–1.75% in 2025. We would expect Mexico’s growth to slow further if the U.S. were to implement tariffs of 25% on Mexican goods and Mexico similarly implemented 25% tariffs on U.S. goods. We would expect that such a development would send Mexico’s inflation high enough that Banxico would need to curtail policy easing.