Market perspectives

Vanguard’s outlook for financial markets

Our annualized nominal return and volatility forecasts are based on the September 30, 2026, running of the Vanguard Capital Markets Model® (VCMM).

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 September 30, 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.

Municipal bond yields at nearly their best in a decade

Municipal bond yields have reached levels that provide tax-sensitive investors with a rare opportunity. While the broader fixed income market has weakened through 2026, municipal bonds have experienced an even steeper decline—not due to softening fundamentals, but because of technical supply-and-demand imbalances.

Unlike much of the year though, when strong supply was met by healthy demand, investors have recently grown more cautious about deploying new capital as they contend with the impact of falling bond prices and elevated volatility.

The yield of the Bloomberg US Aggregate Index rose 83 basis points in the third quarter, primarily due to stronger growth expectations but also fiscal deficit concerns and stubborn inflation. Given the aforementioned technical headwinds, municipal bond yields climbed 120 basis points. After converting Bloomberg US Municipal Index yields to a taxable-equivalent basis, the additional yield pickup over that of the Bloomberg US Aggregate Index has recently been among the greatest in a decade.

Tax-equivalent spreads over broad bond market may represent an opportunity

Source: Bloomberg indexes, using yield-to-worst data as of October 16, 2026.

Notes: Municipal bonds generally pay interest that is exempt from federal income tax, making them particularly attractive to investors in higher tax brackets. Tax-equivalent yield is the yield a taxable bond would need to offer to match the after-tax income from a tax-exempt municipal bond. It is calculated using an assumed combined federal tax rate of 40.8%, consisting of the 37% top federal marginal tax rate plus the 3.8% net investment income tax, which helps fund Medicare.

“Tax-sensitive investors have the opportunity to allocate to the sector at a time when the future for potential returns looks to be in their favor,” said Nate Earle, head of Municipal Fixed Income within Vanguard Client Portfolio Management. “While municipals are unlikely to cheapen significantly versus taxable bonds from current levels, they do have the potential to rally considerably just to get back to long-term median valuations.”

With tax-equivalent yields near 8%, the value proposition appears compelling. But the reason that investors may view these yields as among the best opportunities in a decade isn’t just the yield levels, but also the balance-sheet strength supporting the issuers themselves. Fundamentals are broadly stronger than they have been in years. Further, Vanguard expects the technical factors pressuring valuations to reverse course as we enter the winter months.

“Seasonal issuance pressures typically ease during the winter holiday period through January,” Earle said. “With November approaching, many issuers are working within a narrowing window to bring deals to market. Issuance does not stop when that window closes, but primary market activity often slows meaningfully through year-end.”

Investors who were eager to add municipal bond exposure earlier in the year at less attractive yields may find current levels more appealing.

United States: Growth momentum firming amid notable business spending

Growth continues to demonstrate resilience, with activity tracking at a pace consistent with our 2.3% outlook for 2026. Business investment remains a notable source of strength. Through the second quarter, investment ran at a 9.4% pace, exceeding our already strong expectations coming into the year by more than two percentage points. We expect this capital expenditure cycle to remain an important contributor to growth through 2027. Consumer spending is evolving broadly in line with expectations, supported by tax policy tailwinds and the continued benefits of elevated household wealth.

September payrolls rose by 29,000 jobs, reinforcing our view that monthly payroll growth will remain unusually volatile, as revised figures show payrolls grew by 133,000 in August and fell by 10,000 in July. We continue to characterize the labor market as resilient but not accelerating. Hiring activity remains extremely subdued, with historically low layoffs being the saving grace in keeping the unemployment rate low. The low-hire, low-fire environment, combined with slower labor supply growth, means relatively modest changes in participation dynamics can generate surprisingly strong or weak payroll prints from one month to the next. We therefore expect the recent seesaw pattern in payroll growth to persist.

A somewhat hotter-than-expected Consumer Price Index (CPI) reading released October 14 doesn’t materially change our inflation outlook. However, we are now tracking core inflation as measured by the Personal Consumption Expenditures (PCE) price index at 3.1%, above our 3% forecast for 2026 (fourth quarter over fourth quarter). The balance of risks continues to skew to the upside, reflecting inflationary effects from higher energy prices. The CPI report increases the risk of a previously unexpected Federal Reserve rate increase in October. We continue to view one additional hike this year as most likely. However, the risk has risen for hikes at each of the Fed’s two remaining meetings this year.

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 for each year. For Canada, core inflation is the year-over-year change in the Consumer Price Index (CPI), excluding volatile food and energy prices, as of December for each year. Monetary policy is the Bank of Canada’s year-end target for the overnight rate. For China, core inflation is the year-over-year change in the CPI, excluding volatile food and energy prices, as of December for each year. Monetary policy is the People’s Bank of China’s seven-day reverse repo rate at year-end. For the euro area, core inflation is the year-over-year change in the Harmonized Indexes of Consumer Prices, excluding volatile energy, food, alcohol, and tobacco prices, based on the fourth-quarter average for each year. Monetary policy is the European Central Bank’s deposit facility rate at year-end. For Japan, core inflation is the year-over-year change in the CPI, excluding volatile fresh food prices, as of December for each year. Monetary policy is the Bank of Japan’s year-end target for the overnight rate. For Mexico, core inflation is the year-over-year change in the CPI, excluding volatile food and energy prices, as of December for each year. Monetary policy is the Bank of Mexico’s year-end target for the overnight interbank rate. For the United Kingdom, core inflation is the year-over-year change in the CPI, excluding volatile food, energy, alcohol, and tobacco prices, based on the fourth-quarter average for each year. Monetary policy is the Bank of England’s bank rate at year-end. For the United States, core inflation is the year-over-year percentage change in the Personal Consumption Expenditures price index, excluding volatile food and energy prices, as of December for each year. Monetary policy is the rounded midpoint of the Federal Reserve’s target range for the federal funds rate at year-end.