Vanguard economic and market update: October

22 October 2021 | Markets and Economy


Key points:

  • Expectations for first post-pandemic US interest rate rise brought forward to late 2022.
  • Chinese growth forecast downgraded to just below 8% in 2021 as regulations tightened.
  • Higher inflation now expected in both the United States and United Kingdom.
  • Euro area to reach pre-pandemic growth trajectory around start of 2023, ahead of UK.

Economic growth

Signs of a growth slowdown in the United States appear to be stabilising as the impact of the Covid-19 Delta variant subsides. Supply constraints, however, particularly in the labour market, are likely to keep growth from realising its potential in the third quarter. We foresee GDP growth for the quarter coming in around 5.5% and expect more of the same in the fourth quarter and full-year 2021 growth of around 6%. For 2022, we expect US growth to be around 3.5% to 4%.

A consumption impulse whose timing trailed that of the United States and the United Kingdom is buoying growth and consumer confidence in the euro area. Despite some signs of an easing in momentum, we continue to expect full-year GDP growth of around 5%, which would put the euro area on track to reach its pre-pandemic level of growth in the fourth quarter. We also foresee 2022 growth of around 4%. Although that is lower than in the United Kingdom, where the pandemic-induced fall-off in growth was larger and there’s more ground to recover, we expect the euro area to reach its pre-pandemic growth trajectory around the start of 2023, ahead of the United Kingdom, which faces additional Brexit-related headwinds.

In the United Kingdom, Vanguard continues to expect full-year 2021 growth of around 7%. Official data showed GDP grew by 5.5% in the second quarter, a significant upward revision on the 4.8% growth figure initially given. This revision allows us to maintain our full-year projection even amid recent signs of weakening manufacturing activity. Household sentiment has also taken a marked hit recently, with consumer confidence hitting a six-month low in September amid surging energy prices and a cut to unemployment benefits. For 2022, we forecast growth of around 5.5%, with vaccine- and infection-acquired Covid-19 immunity mitigating the need for economic restrictions.

Data showed the economy in China grew by just 4.9% in the third quarter compared with a year earlier, below market expectations. We expect growth in the fourth quarter of around 1% compared with the third quarter, which is down from our earlier forecast of just over 1.5%. Tighter controls in the property and energy sectors represent fundamental shifts in the Chinese government’s policy priorities and we expect these to continue into 2022, albeit to a slightly more modest degree. As a result, we’ve downgraded our growth forecast for 2021 to slightly below 8%, from a previous range of 8% to 8.5%, and now expect growth of around 5% in 2022 having previously expected around 5.5%. We don’t, however, anticipate deleveraging in the property sector to have a significantly large spillover effect on the banking sector.

Growth in emerging markets is likely to depend in the medium term on inflation and central bank actions. Where inflation is running high, such as Latin America, interest rate hikes have already occurred and may not be finished – a headwind to growth. Where growth is the more immediate concern, however, including some markets in central Europe, rate hikes are less likely, and economic recovery from the pandemic is likely to have fewer obstacles.

Monetary policy

We have moved forward our expectations for the Federal Reserve’s first post-pandemic interest rate rise to late 2022 from the mid-2023 timetable we had anticipated before. This follows revisions to our forecasts for both US inflation and employment (explained in greater detail below). With the Fed’s inflation target largely already met, labour market strength and the Fed’s interpretation of “full employment” remain key to deciding the timing of the next rate hike. Despite a weaker-than-expected September jobs report, Vanguard also believes that the Fed, at its next meeting on 2-3 November, will reveal a timetable for reducing asset purchases, which have supported the economy’s recovery since the pandemic.

A euro area labour market that isn’t as tight as that of the United Kingdom means there’s less upward pressure on wages, a greater feeling that inflationary forces are transitory and less impetus for the European Central Bank (ECB) to dramatically reduce policy accommodation. We expect Pandemic Emergency Purchase Programme (PEPP) asset purchases to be completed in the first half of 2022, though the separate Asset Purchase Programme (APP), with current purchases of €20 billion per month, could be expanded to smooth the transition upon the PEPP’s completion. We believe APP purchases would likely continue until at least 2023, with the ECB raising interest rates in 2024 at the earliest.

The Bank of England (BOE) at its last Monetary Policy Committee (MPC) meeting noted the growing case for modest policy tightening over its forecast period. Meeting minutes published subsequently also showed MPC members agreeing that this tightening could occur, if conditions warranted, before the end of the BOE’s asset purchase programme in December 2021. Vanguard believes the bank will continue with its asset purchases to the end of December, as planned, with most MPC members continuing to want to see how the end of the furlough scheme in September affects the labour market. We do, however, see the BOE raising its bank rate (currently 0.1%) in the first quarter of 2022 due to increased inflation pressures. If upcoming data show the labour market and general activity holding up well, the bank may even be tempted to move in December and follow up with another increase in February.

US government funding

A potential US government shutdown and debt default were both averted in the last few weeks, but the threat of either or both could arise again in early December. On 30 September, the US congress passed and the US president signed a continuing resolution to fund the government through 3 December. Annual appropriations bills need to be signed each fiscal year beginning 1 October to fund the approximately one-third of the federal budget classified as discretionary. To avoid a shutdown in December, an omnibus appropriations bill funding the entire discretionary portion of the budget for the remainder of the fiscal year or another continuing resolution would need to be signed.

Meanwhile, legislation was also passed and signed to raise the US debt ceiling by $480 billion, an amount expected to allow the government to pay its bills until at least December 3. The debt ceiling is the statutory limit on the amount of debt that the US Treasury can have outstanding. With the latest increase, the debt ceiling stands just below $29 trillion.


We have upwardly revised our baseline inflation forecasts for the United States due to employment and other supply constraints that we expect will persist at least into the first quarter of 2022. We now expect core Consumer Price Index (CPI), which strips out food and energy prices, to end this year just below 4.5% year-on-year and end 2022 just above 3%. Previously, we expected it to come in around or above 3% through the first quarter of 2022, settle back just below 2% for some time, and end 2022 above the Federal Reserve’s target of 2%. In the meantime, headline inflation could be in for some volatility with US benchmark crude oil prices rising to levels last seen seven years ago. We foresee higher oil prices adding 20 basis points to headline CPI. But we expect pass-throughs to core inflation to be minimal unless oil prices remain high for a significant time.

Headline inflation in the euro area rose to 3.4% in September compared with a year earlier, up from a 3.0% reading in August. Energy prices contributed nearly half of the September increase. Core inflation, which excludes volatile food and energy prices, was 1.9% compared with a year earlier. With persistent shortages in industrial inputs and the potential for continued run-ups in energy prices, we expect euro-area headline inflation to peak at around 3.5% in the second half of 2021, with core inflation peaking at a range of 2% to 2.5%. But we expect both headline and core inflation to fall back to around 1.5% by the end of 2022, as tax changes wash out of year-on-year calculations and input prices decelerate.

Headline inflation reached 3.1% in September in the United Kingdom compared with a year earlier, easing slightly from a 3.2% year-on-year rise in August. Core inflation also eased to 2.9% year-on-year. We’ve upgraded our outlook for inflation, given a stronger-than-expected surge in natural gas prices and its implications for downstream effects. We now foresee headline inflation rising to around 4.5% in the fourth quarter and core inflation increasing to around 4%. We then expect both to ease over 2022 as the recent end of the furlough scheme releases 1.5 million workers into the jobs market, mitigating labour supply concerns. A further increase to the energy price cap in April 2022, however, is likely to keep some upward pressure on headline inflation, which we see around 2.5% year-on-year at the end of 2022.


Headline job creation was a lower-than-expected 194,000 in September in the United States, with the mid-September survey period likely to have been too early to have captured the job-finders whose pandemic-related unemployment insurance benefits expired in the month. That sets up the October jobs report, to be released on 5 November, as a crucial indicator of the health of the economy. We anticipate a strong October report and monthly job gains averaging 700,000 the rest of the year. But we also expect labour force participation to peak at around 62.3%, a full percentage point below its February 2020 level, before the onset of the Covid-19 pandemic. Though demand for labour is robust, the behavioural and demographic factors that are keeping people out of the labour force are showing signs of persistence.

Unemployment in the euro area inched down to 7.5% in August from 7.6% in July on a seasonally adjusted basis and from 8.6% in August 2020.

The unemployment rate in the United Kingdom fell to 4.5% in the three months to August, from 4.6% in July. The end of the government’s furlough scheme on 30 September is expected to provide additional workers to meet rising job vacancies. But we don’t expect these events to have an appreciable effect on the unemployment rate.

The points above represent the house view of the Investment Strategy Group’s (ISG’s) global economics and markets team as of 20 October, 2021.

Asset class return outlooks

Vanguard’s 10-year annualised outlooks for equity and fixed income returns are unchanged since the September 2021 economic and market update. The probabilistic return assumptions depend on market conditions at the time of the running of the Vanguard Capital Markets Model® (VCMM) and, as such, can change with each running over time.

ISG updates these numbers quarterly. The projections listed below are based on the 30 June, 2021, running of the VCMM. Projections based on the 30 September, 2021, running of the VCMM will be communicated through the November 2021 economic and market update.

Our 10-year annualised nominal return projections are as follows. Please note that the figures are based on a 1-point range around the 50th percentile of the distribution of return outcomes for equities and a 0.5-point range around the 50th percentile for fixed income. Numbers in parentheses reflect median volatility.

British pound investors

UK equities: 4.8%-6.8% (19.2% median volatility)

Global equities ex-UK (unhedged): 2.7%-4.7% (19.0%)

UK aggregate bonds: 0.6%-1.6% (7.6%)

Global bonds ex-UK (hedged): 0.5%-1.5% (3.7%)

Euro investors

Euro area equities: 2.8%-4.8% (24.3% median volatility)

Global equities ex-euro area (unhedged): 1.4%-3.4% (19.0%)

Euro area aggregate bonds: Negative 0.5%-positive 0.5% (3.6%)

Global bonds ex-euro area: Negative 0.6%-positive 0.4% (3.8%)

IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® (VCCM) 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 modelled asset class. Simulations are as of 30 June, 2021. Results from the model may vary with each use and over time.

The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.

The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include US and international equity markets, several maturities of the US Treasury and corporate fixed income markets, international fixed income markets, US money markets, commodities, and certain alternative investment strategies.

The theoretical and empirical foundation for the VCCM is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.



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