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 May 31, 2025, running of the Vanguard Capital Markets Model® (VCMM).

A weaker dollar has benefited diversified U.S. investors

Figure 1 shows how major equity markets have performed this year and highlight the impact of a weakening U.S. dollar, a trend we’ve been expecting to see for some time. Initially undervalued at the beginning of the last decade, the U.S. dollar subsequently gained strength as capital inflows into U.S. equity markets increased. The outperformance of U.S. equities attracted further capital, bolstering the U.S. dollar and driving U.S. equity prices higher. Having lost around 8.0% since its recent peak at the end of 2024, however, the U.S. dollar is now at its cheapest levels since 2022.

The dollar’s decline this year has certainly benefited U.S. investors. In fact, cumulative returns in local currencies significantly lag their equivalent in U.S. dollars. For example, the EURO STOXX 50 Index has returned 9.40% year-to-date in euros compared with a much more robust 22.0% in U.S. dollars 

Our expected returns for U.S. equities have fallen further, as reduced tariff concerns renewed hopes for growth and pushed stock prices higher in May. Equity valuations remained stretched as of May 31. Among equity sub-asset classes, only value and small-cap stocks were undervalued.

The rise in equity valuations reinforced Vanguard’s view that long-term equity returns will remain below historical levels while bonds remain relatively attractive. The equity risk premium in the U.S. is now close to zero, a level seen only twice in the past 70 years. Stocks are more expensive compared with bonds than they have been in nearly 25 years.

On a 10-year annualized basis, the difference between our median U.S. equity and U.S. aggregate bond forecasts narrowed from 0.9 percentage points in our April 30 forecast to 0.1 percentage points in our May 31 forecast.

United States: An improved outlook despite continued policy uncertainty

The U.S. economy has remained resilient despite significant economic policy uncertainty through the first half of 2025. The labor market has cooled but remains stable, and inflation data has come in better than expected. The recent de-escalation of tariff policy with China was a pivotal development, and we have made meaningful, positive revisions to our outlook as a result. Overall, we see a less stagflationary impact to the economy and view the risk of further escalation in trade policy as having been materially reduced. We expect the focus to shift toward fiscal policy in the second half of the year.

Federal Reserve interest rate policy is likely on hold for now, and recent positive tariff developments should mitigate worst-case dual-mandate challenges for the Fed. If the labor market remains on the trajectory we expect, the Fed can afford to be patient. We anticipate that the Fed will be able to make two more rate cuts later this year in this environment. However, policy nuance will be crucial, and uncertainty remains high. Inflation expectations and the persistence of tariff-related inflation are likely to play a central role.

Region-by-region outlook

Source: Vanguard.

Notes: Values are approximate. 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 2025. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, as of December 2025. For Canada, monetary policy is the BoC’s year-end target for the overnight rate. For the United Kingdom, monetary policy is the Bank of England’s bank rate at year-end. For the euro area, monetary policy is the European Central Bank’s deposit facility rate at year-end. For China, monetary policy is the People’s Bank of China’s seven-day reverse repo rate at year-end. For Japan, monetary policy is the BoJ’s year-end target for the overnight rate. For the United States, monetary policy is the upper end of the Federal Reserve’s target range for the federal funds rate at year-end.