The global economy
in 2022: Striking a better balance
Our outlook for 2021 focused on the
impact of COVID-19 health outcomes on economic and financial conditions. Our
view was that economic growth would prove unusually strong, with the prospects
for an "inflation scare" as growth picked up. As we come to the end
of 2021, parts of the economy and markets are out of balance. Labor demand
exceeds supply, financial conditions are exceptionally strong even when
compared to improved fundamentals, and policy accommodation remains
extraordinary.
Although health outcomes will remain
important in 2022, the outlook for macroeconomic policy will be more crucial as
support and stimulus packages enacted to combat the pandemic-driven downturn
are gradually removed into 2022. The removal of policy support poses a new
challenge for policymakers and a new risk to financial markets.
The global economic recovery is
likely to continue in 2022, although we expect the low-hanging fruit of
rebounding activity to give way to slower growth whether supply-chain challenges
ease or not. In both the United States and the euro area, we expect growth to
normalize lower to 4%. In the U.K., we expect growth of about 5.5%, and in
China we expect growth to fall to about 5% given the real estate slowdown.
More importantly, labor markets will
continue to tighten in 2022 given robust labor demand, even as growth
decelerates. We anticipate several major economies, led by the U.S., to quickly
approach full employment even with a modest pickup in labor force
participation. Wage growth should remain robust, and wage inflation is likely
to become more influential than headline inflation for the direction of
interest rates in 2022.
Global inflation:
Lower but stickier
Inflation has continued to trend
higher across most economies, driven by a combination of higher demand as
pandemic restrictions were lifted and lower supply from global labor and input
shortages. Although a return to 1970s-style inflation is not in the cards, we
anticipate that supply/demand frictions will persist well into 2022 and keep
inflation elevated across developed and emerging markets. That said, it is
highly likely that inflation rates at the end of 2022 will be lower than at the
beginning of the year given the unusual run-up in certain goods prices.
Although inflation should cool in
2022, its composition should be stickier. More persistent wage-based inflation
should remain elevated given our employment outlook and will be the critical
determinant in central banks' adjustment of policy.
Policy takes center
stage: The risk of a misstep increases
The global policy response to
COVID-19 was impressive and effective. Moving into 2022, how will policymakers
navigate an exit from exceptionally accommodative policy? The bounds of
appropriate policy expanded during the pandemic, but it's possible that not all
these policies will be unwound as conditions normalize. On the fiscal side,
government officials may need to trade off between higher spending—due to
pandemic-driven policies—and more balanced budgets to ensure debt sustainability.
Central bankers will have to strike a
delicate balance between keeping a lid on inflation expectations, given
negative supply-side shocks, and supporting a return to pre-COVID employment
levels. In the United States, that balance should involve the Federal Reserve
raising interest rates in 2022 to ensure that elevated wage inflation does not
translate into more permanent core inflation. At present, we see the negative
risks of too-easy policy accommodation outweighing the risks of raising short-term
rates. Given conditions in the labor and financial markets, some are likely
underestimating how high the Fed may ultimately need to raise rates this cycle.
The bond market:
Rising rates won't upend markets
Despite modest increases during 2021,
government bond yields remain below pre-COVID levels. The prospect of rising
inflation and policy normalization means that the short-term policy rates
targeted by the Fed, the European Central Bank, and other developed-market
policymakers are likely to rise over the coming years. Credit spreads remain
generally very tight. In our outlook, rising rates are unlikely to produce
negative total returns, given our inflation outlook and given the secular
forces that should keep long-term rates low.
Global equities: A
decade unlike the last
A backdrop of low bond yields,
reduced policy support, and stretched valuations in some markets offers a
challenging environment despite solid fundamentals. Our Vanguard Capital
Markets Model® fair-value stock projections, which explicitly incorporate such
varied effects, continue to reveal a global equity market that is drifting
close to overvalued territory, primarily because of U.S. stock prices. Our
outlook calls not for a lost decade for U.S. stocks, as some fear, but for a lower-return
one.
Specifically, we are projecting the
lowest 10-year annualized return projections for global equities since the
early 2000s. We expect the lowest ones in the U.S. (2.3%–4.3% per year), with
more attractive expected returns for non-U.S. developed markets (5.3%–7.3%)
and, to a lesser degree, emerging markets (4.2%–6.2%). The outlook for the
global equity risk premium is still positive but lower than last year's, with
total returns expected in the range of 2 to 4 percentage points over bond returns.
For U.S. investors, this modest
return outlook belies opportunities for those investing broadly outside their
home market. Recent outperformance has only strengthened our conviction in
non-U.S. equities, which have more attractive valuations than U.S. equities.
Although emerging-market equities are above our estimate of fair value, we
still expect higher returns than the U.S. and diversification benefits for
investors. Within U.S. markets, we think value stocks are still more attractive
than growth stocks, despite value's outperformance over the last 12 months.
Notes:
- IMPORTANT: The projections and
other information generated by the Vanguard Capital Markets Model® (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 as of September 30, 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 U.S. and international equity
markets, several maturities of the U.S. Treasury and corporate fixed
income markets, international fixed income markets, U.S. 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.
- All investing is subject to
risk, including the possible loss of the money you invest. Past
performance is no guarantee of future returns. Diversification does not
ensure a profit or protect against a loss. There is no guarantee that any
particular asset allocation or mix of funds will meet your investment
objectives or provide you with a given level of income.
- Bond funds are subject to the
risk that an issuer will fail to make payments on time, and that bond
prices will decline because of rising interest rates or negative
perceptions of an issuer's ability to make payments.
- Investments in stocks or bonds
issued by non-U.S. companies are subject to risks including
country/regional risk and currency risk. These risks are especially high in
emerging markets.
© 2021 The
Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation,
Distributor.
