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The
Pennsylvania-based mutual fund manager noted a 25% probability
of a U.S. recession over the next 12 months and 65% over the
next two years. In the Euro area, the chance of a recession is
around 50% over the next year and 60% over the next two years,
it estimated.
Vanguard expects the U.S. economy to grow 1.5% this year, down
from its previous 3.5% forecast, it said in a mid-year update of
its 2022 economic and market outlook.
"Central banks have been forced to play catch-up in the fight
against inflation, ratcheting up interest rates more rapidly and
possibly higher than previously expected. But those actions risk
cooling economies to the point that they enter recession,"
Vanguard said.
Recession worries have increased as the U.S. Federal Reserve
tightens monetary policy, with some Wall Street banks in recent
weeks raising their expectations of an economic downturn.
The S&P 500 index is down 20% this year while U.S. government
bonds are on track for their worst year on record, according to
an ICE BofA index which is down nearly 10% this year.
"There is an upside to down markets: Because of lower current
equity valuations and higher interest rates, our model suggests
higher expected long-term returns than our forecasts as of
year-end," Vanguard said.
The Fed last month raised its benchmark overnight interest rate
by three-quarters of a percentage point, its biggest hike since
1994. It is largely expected to deliver a similar interest rate
increase later this month to curb inflation, which has reached
40-year highs.
Vanguard expects the target federal funds rate to range from
3.25% to 3.75% by the end of this year, roughly in line with the
Fed's projections and market expectations. But it said the rate
would reach at least 4% next year, higher than current market
estimates.
While higher rates and growing recessionary concerns have
weighed heavily on bonds and stocks in 2022, Vanguard's
forecasts for long-term investment returns have improved since
the end of last year.
"There's been a deterioration in valuations so valuations have
become more attractive, whether you're talking about higher
yields or lower price-to-earnings multiples in equities
markets," said Andrew Patterson, Vanguard senior international
economist, in an interview.
Ten-year annualized return forecasts for U.S equities now range
from 3.4% to 5.4%, up from 2%-4% at the end of 2021. For U.S.
bonds, forecasts are for 3%-4%, up from 1.5%-2.5% at the end of
last year, Vanguard said.
The improved outlook for bonds means they will continue to offer
diversification for investors using strategies such as the 60/40
portfolio, a standard approach that keeps 60% of assets in
equities and 40% in fixed income, Patterson said.
"We are more constructive on fixed income returns going forward,
unfortunately as a result of some of that yield increase pain
that we felt," he said.
(Reporting by Davide Barbuscia; Editing by Richard Chang)
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