Market perspectives: October 2020

24 September 2020 | Markets and economy


Vanguard insights

The COVID-19 pandemic has accelerated trends already in place, and will also have economic implications that are opaque now but that will become undeniably clear and meaningful over time. So writes Vanguard global chief economist Joe Davis in his most recent blog, “A pandemic-accelerated future.” Among the developments still to play out: whether government stimulus, supply-chain disruptions, and pent-up demand will spur inflation that has been soft for a decade; whether globalization is ending and what that might mean for trade and economic growth; and what central banks can do to support employment and price stability. It's likely, Mr. Davis writes, that the answers to some of these questions will affect the trajectory of others.

Economic growth

The second government estimate of second-quarter GDP in the United States, at negative 31.7%, confirmed an economy-wide collapse in activity led by services. But that data came in at the more optimistic end of Vanguard's forecast range. Some parts of the economy rushed to reopen, leading to a mixed bag of worsening virus infection trends alongside a brighter near-term U.S. economic picture. With these unexpected developments, Vanguard sees a shift forward in growth expectations, with higher economic growth in 2020 owing to less-stringent lockdowns (full-year 2020 GDP around negative 4%, compared with our previous view of negative 7% to negative 9%), but a slower pace of recovery in 2021 (reduced to around 4% growth, compared with a range of 7% to 9% previously). In all, the longer-term picture hasn't changed. We still see it taking until the end of 2021 for GDP to return to pre-COVID levels and into 2022 to reach a pre-COVID trajectory, or where GDP would have been had COVID never happened. Our view anticipates further fiscal stimulus of around $1 trillion; we'd likely reduce our outlooks in the absence of such stimulus.

Vanguard continues to foresee a full-year economic contraction around negative 10% for the euro area economy in 2020 as both headwinds and tailwinds strengthen. GDP readings have been somewhat higher than we had expected at the start of the pandemic, and fiscal policy including the €750 billion Next Generation EU recovery fund and local fiscal measures in Germany, France, and elsewhere should be supportive. At the same time, a strengthening in the euro against other major currencies since May, including a nearly 10% strengthening against the U.S. dollar, is a negative for exports that are now more expensive, which could weigh on GDP. We're also closely watching COVID-19 progression as cases have risen recently in Spain and France, and as more activity is likely to be conducted indoors as the weather starts to turn colder. We expect economic recovery for the rest of the year to be gradual. Although most supply has come back online, it will take longer for demand to return as households remain reluctant to engage in highly social activities. We're also watching whether Spain will extend a job furlough scheme scheduled to expire at the end of September. A softer labor market could further weaken demand in the medium term and increase the risk of negative economic effects. The euro area economy contracted by – 11.8% in the second quarter compared with the first quarter.

The early stages of economic recovery in the United Kingdom were weaker than in the euro area as the trajectory of new virus cases continued high for longer. The U.K. economy grew by 6.6% in July compared with June, but contracted by negative – 7.6% in the three months through July and remained nearly 12% below pre-crisis levels. We expect only gradual recovery the rest of the year. Although most supply is back online, demand is likely to return more slowly as households remain reluctant to engage in highly social activities, especially amid a recent uptick in new cases in some areas. We expect U.K. GDP to be around negative 11% for the full year, in between our baseline and downside cases as set forth in the midyear update of the Vanguard economic and market outlook.

High-frequency indicators and August activity data continued to paint a relatively upbeat picture for growth in China in August. The data make it less likely that policymakers will choose to stimulate the economy, especially as equity and housing prices rise. Retail sales rose by 0.5% in August compared with a year earlier, the first such gain this year, though they're down by 8.6% for the first eight months of the year. Exports remained resilient, up 9.5% compared with August 2019. Vanguard is seeing a broadening in China's export goods after a period where exports were concentrated in protective equipment, medical instruments, and work-from-home technology. We'll watch for whether subdued spending in the developed world may weigh on China's exports in the months ahead. The Caixin China Manufacturing Purchasing Managers Index registered 53.1, remaining firmly above the level of 50 that represents expansion. Vanguard continues to foresee full-year growth for China in a 1% to 3% range.

Vanguard expects the resignation of Prime Minister Shinzō Abe to have little near-term effect on the economy or consumer sentiment in Japan. The nation's longest-serving prime minister announced his resignation on August 28, citing health considerations. We expect a moderate economic rebound in the neighborhood of 5%, above consensus, in both the third and fourth quarters as industrial indicators point to a manufacturing recovery. Rising COVID-19 infection numbers present a risk to spending on services, though we expect the government will take a more targeted approach to mitigation efforts than when the virus first hit. We continue to foresee Japan's full-year GDP contracting in a range around – 3% to – 5%.

GDP fell by – 7.0% in Australia in the quarter ended in June, the largest fall in quarterly Australian GDP since records were first kept in 1959 and confirmation of the nation's first recession in 29 years. Stringent virus containment efforts in Victoria state have been extended through September. But Vanguard's baseline scenario incorporates the possibility of such regional lockdowns and we continue to foresee modest growth in the third and fourth quarters, and a full-year GDP contraction around – 4%. Vanguard is closely watching the housing market, as Australian households typically hold property in their investment portfolios. The pandemic's impact on housing to date has been concentrated in the rental market, with yields down and vacancy rates up. Housing prices fell in the three months through June but remained 6.2% higher than a year earlier amid a low-interest-rate environment and bank payment holidays. We'll especially watch the effect on the housing market when the JobKeeper Payment scheme expires in March 2021.

GDP rose 6.5% in Canada in June compared with May on a seasonally adjusted basis, but was down – 7.8% compared with June 2019. Vanguard's leading indicators and diffusion index (which measures the numbers of leading indicators gaining ground compared with those losing ground) support our view that growth will be gradual following the steep decline owing to COVID mitigation efforts. With fiscal stimulus and commodity prices higher than expected, the risk of permanent impairments to the household and oil sectors are diminishing. We continue to foresee Canada's full-year 2020 contraction at – 5% to – 6%.

The International Monetary Fund lowered its forecast for growth in emerging markets for both 2020 and 2021 on June 24, owing to a rapid intensification of COVID-19 in many emerging and developing nations. The IMF foresees emerging markets contracting by – 3.0% before rebounding to growth of 5.9% in 2021. The outlook for Latin America, under assault from COVID-19, is particularly pessimistic, at a contraction of – 9.4% for all of 2020 before rebounding to 3.7% in 2021, according to the IMF. Emerging markets will be watching developments in U.S.-China relations, which have implications for supply chains and trade-related growth.

GDP in Mexico contracted by – 17.3% in the second quarter compared with the first quarter and by 18.9% compared with the second quarter of 2019.


Negotiations between the United Kingdom and the European Union on a trade deal were presented with a significant obstacle when the United Kingdom introduced legislation on September 9 that would contravene the Withdrawal Agreement that governed the terms under which the United Kingdom ceased being an E.U. member. (Although the United Kingdom formally exited the European Union on January 31, 2020, a transitionary period during which the relationship is unchanged continues through the end of this year. The lack of a trade deal between the parties by then would be akin to the “no-deal” Brexit both sides have worked to avoid the last few years.)

The Internal Market Bill, which passed its second reading in the House of Commons on Tuesday, September 15, by a 340-263 vote, would give ministers the power to modify or even dis-apply rules relating to state aid and the movement of goods between Britain and Northern Ireland if there were no U.K.-E.U. trade agreement by January 1, 2021—a position that the European Union and many political stakeholders (including from within the ruling Conservative party) contend is a breach of international law. The bill includes clauses that could override the Northern Ireland protocol, the part of the Withdrawal Agreement designed to prevent a hard border from returning to the island of Ireland. The bill in essence would require no customs checks on goods moving between Northern Ireland and Britain.

Although the bill passed its first vote in the House of Commons, it is notable that 30 Conservative MPs abstained. The bill is likely to face intense scrutiny during the next stages of the legislative process, particularly when it is reviewed in the House of Lords and amendments that would likely seek to override or dilute the government's proposals are tabled and voted on.

As with most developments concerning Brexit, a lot can change in a short period. But time is running out, and the European Union still maintains it will need to have approved a trade agreement with the United Kingdom by October 15 for the European Parliament to have sufficient time to ratify the deal and for it to take effect by January 1, 2021. In short, the latest development is clearly not positive for the prospects of a trade deal. It remains to be seen whether it marks the point at which negotiations begin to unravel, or whether it will be looked back upon as another seemingly insurmountable hurdle that was eventually overcome.

U.S. government shutdown

Vanguard expects the United States to continue to fund the government beyond September 30, when spending authorization for the discretionary portion of the federal budget winds down. We expect agreement on a continuing resolution to fund the government at least through the November 3 presidential and congressional elections, averting a shutdown in the interim. The government is required to authorize funding each fiscal year for the approximately one-third of the federal budget that isn't authorized automatically. When it doesn't do so, certain government operations cease to function. The last such government shutdown, lasting 35 days, occurred from late December 2018 to late January 2019. The 2021 fiscal year begins October 1.

Monetary policy

Given our expectation for a slow recovery in demand amid pandemic containment efforts, Vanguard continues to expect monetary policy to remain loose into 2021, with risks skewed toward further easing.

The U.S. Federal Open Market Committee (FOMC) voted on September 16 to leave the target range for its federal funds rate unchanged at 0%–0.25%. It was the Fed's first meeting since it announced last month that it would allow inflation to modestly exceed its 2% target so as to achieve 2% average inflation over time. The Fed said it expects to maintain the current target range until it assesses that inflation “is on track to moderately exceed 2% for some time.” FOMC members broadly expect the Fed will keep the current federal funds target rate at today's level through 2023, even as they expect inflation to then finally reach 2%.

The European Central Bank left its main deposit rate unchanged at negative – 0.50% at its policy meeting September 10 and said it would keep its main rates at their current level or take them still lower until it sees the inflation outlook “robustly converge to a level sufficiently close to, but below, 2%.” The ECB additionally said it would maintain purchases under the €1.35 trillion Pandemic Emergency Purchase Program through June 2021 and monthly asset purchases at €20 billion as needed to reinforce its accommodative stance. The ECB didn't address recent euro strength and its potential disinflationary effects in its September 10 monetary policy statement, suggesting that rate cuts also aren't on the horizon. Vanguard expects little change in ECB policy over the next 12 months.

The Bank of England maintained its bank rate at 0.1% and left other policy unchanged on September 17 at its Monetary Policy Committee meeting. However, the committee suggested that the outlook had worsened amid rising COVID-19 cases and renewed Brexit uncertainty. The BOE also indicated it was more likely now than previously that it would implement negative rates in the event of a sustained economic downturn.

The Bank of Japan left its key short-term rate target at negative 0.1% at its meeting September 17. Vanguard believes that the BOJ will not cut rates in 2020 but instead continue with measures aimed at improving corporate financing and yen liquidity.

The Reserve Bank of Australia (RBA) maintained its cash rate and three-year government bond target at 0.25% on September 1, and extended its Term Funding Facility through June 2021. The change brings the total amount of funding available under the program to AUD 200 billion (about USD 150 billion). The program is intended to keep interest rates low for borrowers and support the provision of credit by giving banks greater confidence about continued access to low-cost funding.

Vanguard expects China to largely maintain the status quo in both monetary and fiscal policy as it tries try to balance near-term growth and medium-term financial stability. We expect the People's Bank of China, amid rising equity and housing prices, to delay high-profile stimulus measures such as reserve requirement ratio cuts or to replace them with more targeted, lower-profile measures.

The Bank of Canada (BOC) kept the target for its overnight rate at 0.25% at its September 9 policy meeting. The BOC noted a bounce-back in global and Canadian economic activity in recent months, but cautioned that it expects “this strong reopening phase to be followed by a protracted and uneven recuperation phase, which will be heavily reliant on policy support.” The BOC has expanded is balance sheet by around CAD 400 billion this year. Most of its purchases to date have focused on federal debt, but Vanguard considers it likely that the bank would expand purchases of Canada mortgage bonds and provincial bonds if economic conditions were to deteriorate.


Leading indices continue to suggest that global trade has swung back to an upward trajectory after steep drops in May and June amid COVID lockdowns. The most recent actual data confirms the downturn, but doesn't yet confirm recovery. Similar to the trajectory of broader economic recovery in many places, the leading indices imply a sharp rebound for global trade through October, followed by a slower recovery to pre-pandemic levels. We'd note that global trade was hitting a similar inflection point early in 2020, before the pandemic took hold globally, and was poised for a rebound. We expect global inventory drawdowns prior to the crisis to act as a tailwind to global trade, as firms rebuild depleted inventories even in the absence of a strong rebound in global demand.

China remains the standout country in trade, its exports buoyed by products that were in demand during COVID lockdowns, such as protective gear, pharmaceuticals, and office equipment. China has been supported by its position at the center of global goods production and by lower commodities input prices. Whereas goods typically suffer during a recession, they have prospered in relation to services during the COVID recession, uniquely benefiting China.


The consumer price index in the United States rose 0.4% in August compared with July on a seasonally adjusted basis, having risen 0.6% in July. Compared with a year earlier, the CPI rose by 1.3%, and core CPI, which excludes volatile food and energy prices, rose by 1.7%. Vanguard expects core inflation to remain below 2% over the medium term owing to structural factors such as technology and diminished near-term demand amid the pandemic. We see inflation remaining below 2% by the end of 2021, though virus-related supply shocks, fiscal support and/or monetary stimulus, and willingness by the Federal Reserve to tolerate above-target inflation may serve as potential spurs to higher prices.

The consumer price index in Canada rose 0.1% in August compared with August 2019, after an increase of 0.1% in July. We expect headline CPI to be between 0% and 1% the rest of the year, with substantial fiscal support limiting the downside.

Consumer prices in Tokyo fell 0.7% in August compared with July and 0.1% year-on-year, using the Bank of Japan's preferred core measure, which excludes fresh food and energy. Cultural and recreational services contributed most to the decline, while durable goods prices continued to rise on the back of increased online shopping and fiscal stimulus effects. August CPI for all of Japan will be released Friday, September 18. Vanguard expects inflation to ease through the rest of the year as COVID cases increase, fiscal support wanes, and amid subdued labor market conditions.

Headline inflation fell to negative 0.2% in the euro area on an annual basis in August, according to preliminary estimates, the first slide below zero in four years. Core inflation, which excludes energy and food, alcohol and tobacco, rose just 0.4% on an annual basis, down from 1.2% in July and an all-time low. Vanguard would expect headline and core inflation to begin to converge early next year as the effects of pandemic-related low energy prices fall out of year-on-year comparisons. We expect the euro's recent appreciation against other major currencies—a function of better perceived prospects for the euro area in part because of the €750 billion Next Generation EU recovery fund—to exert disinflationary pressure as less expensive imports and more expensive exports weigh on GDP. We don't expect the core rate of inflation to rise close to the European Central Bank's 2% target over the next 12 months.

Headline inflation in the United Kingdom rose 0.2% in August from a year earlier, compared with a 1.0% rise in July. Vanguard expects inflation to run close to zero in the near term as a consequence of a temporary value-added tax cut in the hospitality and accommodation sectors. But the slump in inflation was broad-based, with only the recreation and culture sector seeing an increase. Over the medium term, we expect demand to recover more slowly than supply and the labor market to weaken, exerting disinflationary pressure on both the core and headline rates of inflation. With the risk of tariff imposition following Brexit, in addition to significant monetary and fiscal stimulus, we foresee inflation rising toward the Bank of England's 2% target within the next two years.

Consumer prices in Australia fell 1.9% in the June 2020 quarter compared with the March 2020 quarter, and by 0.3% compared with a year earlier—the first such contraction since 1997. The data reflect reduced demand during the pandemic. Australia plans to release inflation data for the September 2020 quarter on October 28.

Consumer prices rose at a modest 0.4% in China in August compared with July, and the 2.4% year-on-year increase was the lowest in a year. Food prices accounted for most of the increase. Excluding food, prices were up just 0.1% for both the month and the year, suggesting still-tepid demand among labor market headwinds. Producer prices for manufactured goods rose 0.3% in August compared with July, but were down 2.0% compared with August 2019.


The unemployment rate in the United States fell to 8.4% in August, its fourth straight month of decline, although the pace of job gains has slowed for the last two months. The labor market has surpassed expectations in recent months, and our view that U.S. growth will accelerate for the rest of the year supports our view that the United States will finish 2020 with an unemployment rate in a range of 7% to 9%, lower than our prior view of a range of 8% to 10%.

The unemployment rate in Canada fell for a third straight month in August, to 10.2%, as 246,000 jobs were created. A gain of more than 1.8 million jobs since May leaves Canada within 1.1 million jobs, or 5.7%, from its pre-COVID level. Job losses in the mining and energy sectors were limited, as the sharpest declines in commodities prices proved temporary. The retail and construction sectors have regained the most jobs, on a percentage basis. Vanguard will closely watch the important real estate and finance sectors, where job recovery has been weakest, along with the construction sector for clues about Canada's economic recovery.

Unemployment in the euro area rose to 7.9% in July from a revised 7.7% in June, with the number of unemployed people rising by 344,000. Furlough and other job support schemes have been successful in limiting unemployment rates so far. Vanguard has been encouraged by the recent extension of furlough programs in Germany and France, and believes that Spain will need to follow suit before its program expires at the end of September to avoid a jump in unemployment.

The furlough program in the United Kingdom has similarly limited the unemployment rate, but we expect the rate to rise above 7% in the fourth quarter as the scheme unwinds. We don't anticipate an extension to the scheme unless another national lockdown is initiated. Another wave of unemployment could follow in January 2021 as an incentive to retain furloughed workers expires. We foresee a peak U.K. unemployment rate over 8% in the first half of 2021. The unemployment rate under the official International Labor Organization measure rose to 4.1% in July from 3.9% in June.

The unemployment rate in Australia fell to 6.8% in August from 7.5% in July, the first decrease since the start of the pandemic. Job losses in the Victoria state, where strict virus lockdowns were in place, were more than offset by gains elsewhere; Vanguard can foresee the potential for further Victoria job losses being reflected in September numbers. Australia's underemployment rate, reflecting people who wanted to and were available to work more than they did, remained at 11.2%, or 2.4 percentage points higher than before the pandemic. Most of the job gains in August were reported by self-employed individuals. Separately, Vanguard sees an extension of the JobKeeper worker-retention program through March 2021 as a positive development, even as payments will be reduced after September.

The unemployment rate in China fell to 5.6% in August from 5.7% in July. The unemployment rate in Japan increased to 2.9% in July from 2.8% in June.

Asset class return outlooks

Vanguard's 10-year annualized outlooks for equity and fixed income returns are unchanged since the September 2020 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.

Our 10-year annualized 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.

Vanguard's 10-year annualized outlook for asset class

U.S. equities 3.9%-5.9% (17.9% median volatility)
Global equities ex-U.S. (unhedged) 7.4%-9.4% (18.6%)
U.S. value 5.0%-7.0% (19.9%)
U.S. growth 1.6%-3.6% (19.5%)
U.S. large-cap 3.7%-5.7% (19.4%)
U.S. small-cap 4.0%-6.0% (23.5%)
U.S. REITs 3.4%-5.4% (19.9%)
U.S. aggregate bonds 0.7%-1.7% (4.0%)
U.S. Treasury bonds 0.3%-1.3% (4.2%)
Global bonds ex-U.S. (hedged) 0.5%-1.5% (2.5%)
U.S. credit 1.4%-2.4% (5.7%)
U.S. high-yield corporate 3.2%-4.2% (10.7%)
Emerging market sovereign 3.1%-4.1% (11.1%)
U.S. TIPS 0.4%-1.4% (6.4%)
U.S. cash 0.5%-1.5% (0.9%)
U.S. inflation 0.5%-1.5% (2.4%)

These probabilistic return assumptions are from a U.S. investor's perspective. They depend on current market conditions and, as such, may change over time.

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. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of June 30, 2020. Results from the model may vary with each use and over time.

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This information is intended for investors outside the United States and should not be provided to individual investors in the United States. The information contained herein does not constitute an offer or solicitation and may not be treated as such in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. Broker-dealers, advisers, and other intermediaries must determine whether their clients are eligible for investment in the products discussed herein.

All investing is subject to risk, including possible loss of the money you invest.

Investments in bonds are subject to interest rate, credit, and inflation risk.

IMPORTANT: The projections and 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 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.