The views below are those of the global economics and markets team of Vanguard Investment Strategy Group as of January 19, 2023.

Our 10-year annualized nominal return and volatility forecasts are shown below. They are based on the September 30, 2022, running of the Vanguard Capital Markets Model® (VCMM). Equity returns reflect a 2-point range around the 50th percentile of the distribution of probable outcomes. Fixed income returns reflect a 1-point range around the 50th percentile. More extreme returns are possible.

The Federal Reserve’s choice of a 25 or 50 basis-point (0.25 or 0.5 percentage-point) interest rate hike at its February 1 policy meeting is less important than the rate peak it ultimately chooses and how long the peak is maintained. We expect the federal funds rate to reach 5%–5.25% during the first quarter, and that policymakers will target that level for the rest of 2023.

• From the Fed’s perspective, the U.S. economy’s near-term future comes down to balancing two risks: that insufficiently restrictive monetary policy would allow inflation to rekindle and spiral out of control, and that the cumulative effects of overly restrictive policy would unnecessarily curtail economic activity. The Fed remains more concerned about inflation.
• We forecast that the rate of core inflation (price changes excluding food and energy) will be just below 3% on a year-over-year basis at the end of 2023, still above the Federal Reserve’s 2% inflation target.
• We expect months of U.S. job losses this year and an unemployment rate of 4.5%–5% at year-end (up from 3.5% in December).
• The first reading of fourth-quarter GDP, due January 26, likely will reflect annualized growth of about 3%.
• We still assign a 90% probability to a U.S. recession in 2023 and view a path to a soft landing as exceptionally narrow. We expect only marginal growth, around 0.25%, for the full year.

Learn more. Watch Senior International Economist Andrew Patterson explain what Vanguard’s global economics team will be watching for in inflation data in the year ahead (1:21 video). 

We had expected a gradual exit from China’s zero-COVID approach, but policymakers now appear adamant about removing all COVID controls, even as the virus overwhelms China’s health system. That development and stronger-than-expected economic data lead us to upgrade our forecast for full-year 2023 growth from 4.5% to 5.3%.  

• The risks to our updated outlook are tilted toward the upside. Homebuyers and other consumers could tap deeper into what we estimate to be 1.5 trillion yuan (about $220 billion) in excess savings accrued during the pandemic.
• The key downside risks are the potential emergence of recurring waves of COVID infections that would restrain the recovery in consumption, and a deeper-than-expected global downturn.
• Given our outlook for a recovery in consumption, we’ve raised our inflation forecasts. We expect core inflation in China to average 1.5% in 2023 (up from just 0.9% in 2022), and headline inflation of 2.5% (2.0% in 2022), still well below the 3% target of the People’s Bank of China.
• Globally, a normalizing Chinese economy that reduces the risk of global supply chain disruptions could combine with fading demand in developed countries to drive goods deflation. Stronger tourism and transportation activity, on the other hand, likely would be inflationary. 

When the European Central Bank (ECB) lifted the interest rate paid to banks on overnight deposits by 50 basis points, to 2%, in December, policymakers forecast that inflation would remain above their 2% target through 2025. The ECB said it expects to raise rates “significantly further, because inflation remains too high and is projected to stay above the target for too long.”

• We expect the ECB to raise the deposit facility rate to a 3.5% peak in the second quarter, higher than the 2.5% terminal rate we envisioned in our 2023 economic and market outlook (61-page PDF). We further expect the ECB to leave its key rate at that highest-of-cycle level for a full year, cutting rates in the second half of 2024 at the earliest.
• The implications for economic growth are negative, and we see elevated risks for a double-dip recession toward the end of 2023 and into 2024, given lagged effects of monetary policy and a potentially more challenging environment for procuring energy ahead of the 2023–2024 winter.
• For full-year 2023, we now expect gross domestic product (GDP) to contract –0.5% to –1%. We previously forecast that GDP would be unchanged relative to 2022.
• Our forecast for headline inflation around 3.2% at year-end 2023 is unchanged. 

The United Kingdom likely, narrowly avoided a recession in 2022. The need for tighter monetary policy amid elevated inflationary pressures is one reason we believe the United Kingdom economy will enter a recession in 2023.

• We believe a U.K. recession will be deeper and longer than one in the euro area. We continue to expect GDP to contract 1%–1.5% in 2023.
• High energy prices stressed consumers in 2022; the mortgage market may be the next point of pain. In a country where most mortgage rates are fixed for only two to five years, we estimate that 35%–40% of mortgage holders will face sharply higher rates in 2023.
• We continue to expect the Bank of England to lift its target interest rate to 4.5% early in 2023 and to keep it there for the rest of the year. 
• Headline inflation appears to have peaked at a year-over-year rate of 11.1% in October. We expect headline inflation to average 6%–6.5% in 2023. 

The Bank of Mexico raised its overnight interbank rate target to 10.5% in December and signaled another hike at its February 9 monetary policy meeting. It also said, however, that inflation likely peaked in 2022 and should fall to the bank’s 3% target by year-end 2024. A similar scenario is playing out elsewhere in Latin America, where slowing global growth and slowing inflation should take pressure off central banks in 2023.

• Investor expectations for rate cuts in Latin America in 2023, implied by market pricing, are consistent with our view that slowing global growth will weigh on growth in emerging markets. In emerging Asia, where exports have begun to slow, we doubt central banks will deliver the rate hikes that markets expect.
• Given a slowing global economy and further anticipated developed-market central bank rate hikes, we expect below-consensus economic growth of about 3% for emerging markets in 2023.
• Inflation likely has peaked in Latin America and neared its peak in emerging Asia, though not yet in emerging Europe, where challenges reflect those of the continent’s developed markets.

Learn more. Watch Roger Aliaga-Díaz, Vanguard’s chief economist for the Americas, discuss why Latin American growth may disappoint in 2023 (3:19 video; links to Vanguard website for South America).

Inflation likely has peaked, and the Bank of Canada (BOC) may have reached its terminal interest rate. Headline inflation was 6.3% compared with a year earlier in December, down from 6.8% year-on-year in November. The pace of core inflation also slowed.

• We believe the BOC will pause its rate hiking cycle at its January 25 policy-setting meeting, leaving the overnight rate at 4.25% at least until late 2023, when a mild recession may allow for talk of a rate cut. 
• Some labor market indicators have weakened, including a survey of businesses on hiring expectations, suggesting a labor market slowdown toward the middle of 2023.
• Our forecast for economic growth is unchanged. We expect 2023 growth of less than 1%.

On December 6, the Reserve Bank of Australia (RBA) lifted its cash rate target by 25 basis points to 3.1%, its highest level in a decade. The RBA’s meeting minutes revealed that the bank’s board considered leaving the cash rate on hold for the first time since the current rate-hiking cycle began in May 2022.

• We’ve lowered our forecast for the RBA’s terminal rate to 3.85% from 4.35%, still an above-consensus view. But we believe the bank will keep its cash rate target at the terminal rate for longer, implying a lower probability of rate cuts in 2023.
• Inflation is likely to peak soon around 8% as rising interest rates dampen domestic demand and fuel prices moderate. The tight labor market and higher wage growth likely will keep inflation above 4% through 2023. 
• We still forecast 2023 economic growth of about 1.25%, lower than the 1.8% consensus estimate. Growth should slow as higher mortgage payments and lower home prices dampen consumption and as post-pandemic government spending normalizes. We place the chance of recession in 2023 at 40%. 

• The debt limit—we’ve been here before (article, issued January 2023)
• 2023 economy and markets: 4 things to know (article, issued December 2022)
• Strategic asset allocation matters (hub of insights, various publication dates)