Commentary by Jumana Saleheen, Vanguard European chief economist.


  • 2022 was a challenging year for equity and bond investors.
  • A number of key macro and market themes could determine the course of investment markets over the coming year.
  • Patient multi-asset investors that maintain discipline with a strategic allocation to global equities and bonds are likely to be rewarded over the long term.


Last year was in many ways an annus horribilis for investors. War erupted in Europe; global inflation—benign for a number of years—surged to generationally high levels; and central banks responded by tightening monetary policy at the sharpest pace since the 1970s. Investors, meanwhile, were hard pushed for places to hide amid the turmoil, as global equity and fixed income markets both posted their worst run of performance in decades, recording double-digit negative returns for the year.

After such an eventful 2022, the big themes on many investors’ minds have evolved. Here we look at how the key macro and market questions for investors have shifted over the past year and how the answers to these questions could determine the course of investment markets over the coming year.

How the narrative has shifted over the past year

Source: Vanguard

How persistent will inflation be?

In 2022 the key question was “How high will inflation go?” The focus has now shifted to “How long will inflation stay above central banks’ 2% inflation target?” The answer lies in the labour market and wage growth.

Having reached multi-decade highs in 2022, inflation has likely peaked in the US, UK and euro area. To gauge how long inflation will stay above central banks’ target we look to underlying inflation pressures, best measured by wage growth. As such, in 2023 all eyes will be on the tightness of the labour market and wage growth. Our view is that wage growth needs to fall from current levels of 5-6% to 3%-4%, to be consistent with the inflation target of central banks.

Our forecasts are for inflation to reach around 3.0% in the US, 3.4% in the euro area and 4.4% in the UK by the end of 2023. In other words, we do not see inflation returning to target until 2024 or early 2025.

Our global 2023 base case

* For the U.S., GDP growth is defined as the year over year change in fourth quarter gross domestic product. For all other countries/regions, it is defined as the annual change in total GDP in the forecast year compared with the previous year.

Source: Vanguard. Vanguard economic and market outlook for 2023: Beating back inflation, December 2022.


When will interest rates peak?

In 2022, financial markets were focused on how high interest rates would go. But in 2023 the emphasis is more around when rates will peak, and whether we might see rate cuts.

2022 was a year of unprecedented monetary tightening – the largest since the 1970s. Rates were raised in earnest by the US Federal Reserve (Fed), the European Central Bank and the Bank of England to stop high inflation from becoming embedded into the economy. Our view is that the rapid monetary tightening of 2022 will ultimately succeed in bringing down inflation, but it will come at the cost of economic growth.

Annual central bank interest rate rises

Source: Bloomberg and Bundesbank, as of 6 January 2023. Note: Discount and Lombard rates used for Germany pre-1999.


Financial markets are more optimistic about the inflation outlook than central banks, particularly for the US. It has led them to price in at least one rate cut by the Fed at the back end of 2023. But given recent price and wage dynamics, our view is that major central banks will continue to raise rates in 2023, and then hold rates at their peak levels for the rest of the year. Our baseline outlook is for the US federal funds rate to reach a peak of between 5% and 5.25%. In the euro area and the UK, we forecast terminal rates1 of 3.5% and 4.5%, respectively.

What type of recession can we expect?

High inflation and rising interest rates throughout 2022 lowered households’ real disposable income, heightening fears of recession. In 2023 investors’ attention is likely to shift to “What type of recession will we see?”

The answer could be a “Zoom recession”2. During the Covid-19 pandemic, especially in the US, a number of sectors—such as real estate, transportation and warehousing and IT—were boosted by the impact of lockdowns on consumer behaviour. As a result, companies in these sectors may have hired too many workers. Conversely, sectors which were depressed by Covid-19—such as education, health services and leisure and hospitality—hired too few workers.

As the economy normalises to post-pandemic conditions, we expect job losses in 2023 to be concentrated in the Covid-19-boosted sectors and for staffing shortfalls in the Covid-19-depressed sectors to ease slightly.

Vanguard’s leading indicator of economic activity points to a recession in the UK and euro area 2023, with a mild recession expected in the US mid-year. However, momentum in the data has been stronger than expected, suggesting that the recession could be milder, or narrowly avoided in some regions.

When will equities start to recover?

2022 was a dismal year for equities. US equities returned -18.11%, while UK and euro area equity indices returned 0.34% and -10.14%, respectively, in local currency terms3. Investors are now pondering “When will equities start to recover?” History tells us that it is hard—if not impossible—to time turning points in the market.

The US equity market—which represents more than half of global stock market capitalisation4—still faces downside risk as it has yet to drop materially below its fair-value range, which it has historically done during recessions.

However, globally, valuations are approaching fair value, and longer term, our global equity outlook is improving because of lower valuations and higher interest rates. It’s important to note that over- or undervaluation should not, in itself, suggest a short-term action on the part of investors. Rather, we advocate a rigorous investment approach combined with the principles of broad global diversification aligned with an investor’s goals and constraints.

Will bonds rally?

The sharp rise in interest rates in 2022 caused a sharp fall in bond prices, and as a result bond performance in 2022 was substantially weaker than in previous decades. Investors are wondering whether 2023 will be different.

Global annual bond returns comparison

Past performance is not a reliable indicator of future results.

Notes: Bond performance derived from the Bloomberg Global Aggregate Bond index from 2000 to 30 June 2022 (in USD). Each line represents bond market performance during a particular year; the red line shows performance in 2022; the black lines show performance in 2020 and 2007; the grey lines show performance for all other years since 2000. Year-to-date returns as at 31 December 2022. Source: Bloomberg & Vanguard as at 5 January 2023.


When interest rates rise, bonds re-price lower immediately. However, cash flows can then be reinvested at higher rates. Given enough time, the increased income from higher coupon payments will offset the price decline and an investor’s total return from bonds should increase.

Moreover, our view is that after a decade of near-zero and low interest rates, we are transitioning to a period of higher rates. Higher rates result in higher bond yields, which means long-term investors are likely to become more optimistic about the return prospects from the fixed income part of their portfolios. Once markets become confident that central bank policy rates have peaked, we could see a bond price recovery.

As bond prices fell in tandem with stock markets in 20225, some investors questioned the role of bonds in portfolios. We continue to believe that the inclusion of bonds is warranted as a portfolio stabiliser and a long-term diversifier against equity market risk6

Putting the equity and bond outlooks together, there may yet be further volatility in markets in 2023. But patient multi-asset investors that maintain discipline with a strategic allocation to global equities and bonds are likely to be rewarded over the long term. Indeed, Vanguard’s expectation for long-term stock and bond returns have increased compared with this time last year. Because it is challenging to time the recovery of asset prices, to have the best chance of investment success, we think investors should stay the course and maintain a long-term perspective.


1 The terminal rate is the interest rate which policymakers expect to attain before they end rate hikes.

2 Zoom is a US video communications technology company. It was one of the companies to benefit from the impact of Covid-19-related lockdowns on the economy. However, the phrase “Zoom recession” in this piece is used more generally to capture a broad range of sectors that were boosted by Covid-19.

3 Source: Vanguard, based on data from Refinitiv. The S&P 500 index, the FTSE all-share index and the Stoxx Europe 600 index returned -18.11%, 0.34% and -10.14% respectively in 2022 (total return in local currency terms).

4 Source: Vanguard. As at 31 December 2022, 58.9% of the market capitalisation of the FTSE Global All Cap Index was represented by companies based in the US.

5 Vanguard calculations in GBP, based on data from Refinitiv, as at 31 October 2022. Global equities represented by the MSCI AC World Total Return Index Sterling. Global bonds represented by the Bloomberg Global Aggregate Index Sterling Hedged.

6 Source: Vanguard. Vanguard economic and market outlook for 2023: Beating back inflation, December 2022. Despite their historic sell-off this year, including fixed income in the portfolio still improved results because bonds are a lower-volatility asset. Our research (Wu et al., 2021) finds that asset allocation matters more than correlation regime when estimating outcomes over a long-term horizon.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Past performance is not a reliable indicator of future results.

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