• In the 2025 Vanguard economic and market outlook, we look beyond the landing, adopting a framework centred on the supply-side forces, such as productivity growth and a surge in available labour, that have shaped the US economy.

• The era of sound money—characterised by positive real interest rates—lives on. This environment sets the foundation for solid fixed income returns over the next decade.

• Our equity view is more cautious. Ultimately, high starting valuations will drag down long-term returns. But history shows that US equity market returns can continue to defy their valuation gravity in the near term. Valuations of equity markets outside the US are more attractive.

Read the extended global outlook summary of Vanguard’s full economic and market outlook, “Beyond the landing”:

A new narrative for the economy and markets 

The market narrative of the past two years has focused on whether the US Federal Reserve (Fed) can perfectly time its rate-cutting cycle to achieve painless disinflation. Has the US achieved a soft landing? Or will the impact of high interest rates eventually lead to a hard landing? 

But in the Vanguard 2025 economic and market outlook, we propose that this emphasis on the “landing” may not fully explain the exceptionally strong growth and falling inflation that we’ve witnessed in the US. 

Rather, the forces that do explain it suggest a new narrative for the economy and markets. In our 2025 outlook, we look beyond the landing, adopting a framework centred on the supply-side forces, such as productivity growth and a surge in available labour, that have shaped the US economy. This framework is also suited to taking account of emerging risks, such as those related to immigration policies, geopolitics or potential tariffs.

US economic resilience not driven by Fed policy

Against the backdrop of restrictive monetary policy, the US economy has had the favourable combination of strong real GDP growth, the loosening of overly tight labour markets and falling inflation. But, in our view, US robustness may owe more to fortuitous supply-side factors than to a “soft landing” engineered by the Fed.

While the positive supply-side drivers of growth may continue in 2025, emerging policy risks, such as the implementation of trade tariffs and stricter immigration policies, may offset gains. Under such a scenario, US real GDP growth would cool from its present rate of around 3% to closer to 2%. 

Economies outside of the US have been less lucky on the supply side, and thus unable to achieve the same combination of strong growth alongside significantly reduced inflation. Euro area growth is expected to remain below trend next year, as a slowdown in global trade represents a key risk. 

Vanguard’s 2025 economic forecasts 

Notes: Forecasts are as of 12 November 2024. For the US, GDP growth is defined as the year-over-year change in fourth-quarter GDP. For all other countries/regions, GDP growth is defined as the annual change in GDP in the forecast year compared with the previous year. Unemployment forecasts are the average for the fourth quarter of 2025. NAIRU is the nonaccelerating inflation rate of unemployment, a measure of labour market equilibrium. Core inflation excludes volatile food and energy prices. For the US, euro area, UK and Japan, core inflation is defined as the year-over-year change in the fourth quarter compared with the previous year. For China, core inflation is defined as the average annual change compared with the previous year. For the US, core inflation is based on the core Personal Consumption Expenditures Index. For all other countries/regions, core inflation is based on the core Consumer Price Index. For US monetary policy, Vanguard’s forecast refers to the top end of the Federal Open Market Committee’s target range. China’s policy rate is the seven-day reverse repo rate. The neutral rate is the equilibrium policy rate at which no easing or tightening pressures are being placed on an economy or its financial markets. 

Bond returns: The era of sound money sets a solid foundation  

The era of sound money—characterised by positive real interest rates—lives on. Although central banks are now easing monetary policy, we maintain our view that policy rates will settle at higher levels than in the 2010s. This environment sets the foundation for solid fixed income returns over the next decade.

Higher starting yields have greatly improved the risk-return tradeoff in fixed income. Bonds are still back. Over the next decade, for euro investors, we expect 2.2%-3.2% annualised returns for euro area bonds and 2.3%-3.3% for currency-hedged global ex-euro area bonds¹. This view reflects a gradual normalisation in policy rates and yield curves, though important near-term risks remain. 

The strong outlook for fixed income (together with a more cautious long-term view for US equities, which we explore below) means that—for investors with an appropriate risk profile—more defensive portfolios may be appropriate, given that the extra compensation for taking on more risk remains low relative to history. We expect a 60/40 portfolio² to return 2.5%-4.5% over the next decade. 

Equity returns: Rational or irrational exuberance? 

Our equity view is more cautious. US equities have generally delivered strong returns in recent years. 2024 was no exception, with both earnings growth and price/earnings ratios exceeding expectations. The key question for investors is, “What happens next?”

While the US equity return outlook over the next decade at 0.7%-2.7% (for euro investors) may appear overly cautious—as does the outlook for global equities at 2.1%-4.1%, given that 68% of this universe consists of US equities—the range of possible outcomes is wide and valuations are rarely a good timing tool³. Ultimately, high starting valuations will drag long-term returns down. But history shows that, absent an economic or earnings growth shock, US equity market returns can continue to defy their valuation gravity in the near term.

Valuations of equity markets outside the US are more attractive. During the past few years, persistently lacklustre growth in the economies and earnings outside the US have kept global ex-US equity returns lukewarm relative to the remarkable return in the US market. We suspect this could continue as these economies are likely to be most exposed to rising global economic and policy risks.  In the longer run, however, differences in price/earnings ratios are the biggest driver of relative returns. Over the next decade, we expect both euro area equities and developed markets ex-US equities to return 5.1%-7.1% and emerging market equities to return 3.1%-5.1%, all from a euro investor’s perspective⁴. 

A new point of tension emerging

The investment challenge is a growing point of tension in risk assets between momentum and overvaluation. Assets with the strongest fundamentals have the most stretched relative valuations, and vice versa. The economic and policy risks for 2025 will help determine whether momentum or valuations dominate investment returns in the coming year.

¹ Euro area bonds represented by the Bloomberg Euro-Aggregate Bond Index, global ex-euro area bonds (hedged) represented by the Bloomberg Global Aggregate ex Euro Bond Index Euro Hedged. 

² The 60% equity/40% fixed income portfolio is represented by global equities (MSCI AC World Total Return Index Euro) and hedged, global bonds (Bloomberg Global Aggregate Bond Index Euro Hedged). 

³ US equities represented by the MSCI USA Total Return Index Euro, global equities represented by the MSCI AC World Total Return Index Euro.

⁴ Euro area equities represented by the MSCI Economic and Monetary Union (EMU) Total Return Index, developed market ex-US equities represented by the MSCI World ex USA Total Return Index Euro, emerging market equities represented by the MSCI Emerging Markets Total Return Index Euro.
 

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. VCMM results will 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 U.S. 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 Vanguard Capital Markets Model 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.

The primary value of the VCMM is in its application to analysing potential client portfolios. VCMM asset-class forecasts—comprising distributions of expected returns, volatilities, and correlations—are key to the evaluation of potential downside risks, various risk–return trade-offs, and the diversification benefits of various asset classes. Although central tendencies are generated in any return distribution, Vanguard stresses that focusing on the full range of potential outcomes for the assets considered, such as the data presented in this paper, is the most effective way to use VCMM output.

The VCMM seeks to represent the uncertainty in the forecast by generating a wide range of potential outcomes. It is important to recognise that the VCMM does not impose “normality” on the return distributions, but rather is influenced by the so-called fat tails and skewness in the empirical distribution of modeled asset-class returns. Within the range of outcomes, individual experiences can be quite different, underscoring the varied nature of potential future paths. Indeed, this is a key reason why we approach asset-return outlooks in a distributional framework.

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