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Last time, we looked at Vanguard’s May quarterly update for Canada, weighing the impact of rate hikes, economic growth, and excess demand on the outlook. This time, we’ll look at our outlook for the U.S. as well as future expected returns for global and Canadian bonds and equities.
After over a year of rapid growth, the U.S. economy surprisingly contracted at a 1.4% annualized rate in the first quarter of 2022 versus a consensus estimate of a 1% gain. The decline was caused by a reduction in fixed investment, defence spending, and a widening trade deficit. The current slowdown leads us to revise downward our forecast for full-year growth to around 3.4% from our previous expectation of 4%.
U.S. inflation increased to a four-decade high of 8.5% year-over-year in March because of higher consumer demand, supply shortages, and rapidly rising food and energy prices.
In addition, more than 400,000 jobs have been consistently created for eleven months, bringing the average unemployment rate to around 3.6% in the first quarter, almost a multi-decade low. An exceptionally strong labour market recovery is on pace for mid-3% unemployment rate in the second quarter of 2022. The labour force is expected to add another half a million workers by the third quarter, with the labour force participation rate peaking around 63%. We expect average monthly job growth of 280,000 in 2022.
On May 4, with record inflation levels and a strong labour market, the U.S. Fed increased its key rate by 0.5% and announced the commencement of quantitative tightening – removing economic stimulus that helped bring down the medium- and long-term interest rates at the onset of the pandemic.
Our outlook for monetary policy remains hawkish over broadening inflation pressures and an overall tighter labour market. We see further policy rate tightening in the first half of the year and continue to view an ultimate terminal rate of around 3%, which is above the Fed’s estimate of a neutral rate, and can be construed as a risk to current market pricing. For the year, we expect six to eight policy rate increases of 25 bps each1.
Key risks. Geopolitical risks, energy prices, and a Fed policy misstep resulting in a recession remain the key risk factors for the economy. At present we see less sensitivity to these risks in the U.S. relative to Euro area; however, escalations coupled with persistently tighter financial conditions and oil prices in the $125-$150 (per barrel of WTI oil) range would present significant cyclical risks.
The growth environment in the Euro area is challenged by the war in Ukraine, the resulting higher energy prices, reduced confidence, and somewhat tighter financial conditions. We continue to foresee full-year growth in a range of 2.5% to 3%, lower than our outlook before the war for growth around 3.5%.
Worsening Covid-19 outbreaks have led to lockdowns affecting more people in China than at any other point since 2020 and purchasing managers’ index readings imply that a sharp economic slowdown took hold in March. China set an official 2022 growth target “around 5.5%” at the early-March National People’s Congress, the lowest growth target it has ever set. Vanguard maintains its forecast for 2022 China growth around 4%-5%. Fiscal and monetary stimulus early in the year boosted the economy in January and February, offsetting the March weakness.
Vanguard continues to see an economic growth of around 5.5% in emerging markets broadly in 2022, but high food and energy prices related to the war in Ukraine place risks firmly to the downside. Energy prices have risen steadily since the start of the year but have moderated at elevated levels recently. And although higher commodities prices benefit some emerging economies, they negatively impact these economies when taken in aggregate.
Looking ahead, our fair-value projections reveal a global equity market that has gone through a significant price correction since November 2021 and is likely to produce better returns than previously estimated, over the next 10 years. With higher interest rates, bond return expectations have also improved compared to the last quarter.
Canadian and global equities
With sizable reductions in equity values across the Canadian and global markets since January, we have improved our long-term outlook for equity returns. Our median 10-year returns expectations for Canadian equities at the end of April 2022 are in the range of 3.4% to 5.4%, about 0.4% higher than our January 2022 estimate. For global stocks (ex-Canada, unhedged), our forecasts have also improved by nearly 85 bps to a 4.3%-6.3% range.
Canadian and global bonds
With rising nominal yield levels observed across developed markets because of higher inflation and consistently higher interest rate expectations, we now see a marked improvement in bond returns over the next 10 years.
At the end of April 2022, we anticipate that median 10-year returns for Canadian bonds will range from 2.9% to 3.9%, a 1.14% increase from our forecast in January. Likewise, for global aggregate bonds (ex-Canada, hedged), we now anticipate median 10-year returns of 2.65%-3.65%, about a 120-basis points improvement since the beginning of the year.
We take a long-term view on investing, and we encourage our clients to do so as well. While the ranges of our expected 10-year median returns are below recent returns, global equities are anticipated to continue to outperform most other investments and the rate of inflation.
Notes
1. Of those 6-8 hikes, Fed already hiked the key rate by 50 bps on May 4, which is counted as two of our anticipated 2022 hikes.
2. All returns are annualized median expected returns over the next 10 years, as of May 6, 2022, using Vanguard Capital Markets Model.
Bilal Hasanjee, CFA, MBA, MSc Finance, is Senior Investment Strategist at Vanguard Investments Canada.
Disclaimer
© 2022 by Vanguard Group. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Insights“ page of the Vanguard Group, Inc.’s website. Used with permission.
The views expressed in this material are based on the author's assessment as of the first publication date (July 2021), are subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc. The author may not necessarily update or supplement their views and opinions whether as a result of new information, changing circumstances, future events or otherwise.
Certain statements in this presentation may be considered "forward-looking information" which may be material, involve risks, uncertainties or other assumptions and there is no guarantee that actual results will not differ significantly from those expressed in or implied by these statements. Factors include, but are not limited to, general global financial market conditions, interest and foreign exchange rates, economic and political factors, competition, legal or regulatory changes and catastrophic events. Any predictions, projections, estimates or forecasts should be construed as general investment or market information and no representation is being made that any investor will, or is likely to, achieve returns similar to those mentioned herein.
While this information has been compiled from proprietary and non-proprietary sources believed to be reliable, no representation or warranty, express or implied, is made by The Vanguard Group, Inc., its subsidiaries or affiliates, or any other person (collectively, "The Vanguard Group") as to its accuracy, completeness, timeliness or reliability. The Vanguard Group takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this material.
Information, figures and charts are summarized for illustrative purposes only and are subject to change without notice.
In this material, references to "Vanguard" are provided for convenience only and may refer to, where applicable, only The Vanguard Group, Inc., and/or may include its affiliates, including Vanguard Investments Canada Inc.
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.
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