Vanguard's New Perspective: Market Optimism Put to the Test

The index fund and ETF giant Vanguard expects that the Federal Reserve's interest rate easing measures will be less extensive than markets anticipate, as inflation remains persistently high. According to the company's economic and market forecast for 2025, U.S. GDP growth will decline to 2.1% next year. Vanguard's research team, led by Chief Economist Joseph Davis, predicts that core inflation will remain above 2.5% in 2025 despite recent progress. This forces the Fed to keep its key interest rate at or above 4% by the end of the year, rather than significantly lowering it. For investors, Vanguard's forecast questions the market's expectations of aggressive Fed rate cuts and suggests that an alternative course may lie ahead as inflation persists and economic growth remains robust despite two years of restrictive monetary policy. Looking to the coming year, Vanguard sees U.S. growth driven mainly by productivity enhancements and available labor force, rather than monetary policy. These supply-side factors contributed to strong GDP growth of 3% in 2023 while inflation eased. However, Vanguard warns of new political risks, such as stricter immigration rules and trade tariffs, that could offset these positive supply factors. For the Eurozone, growth is forecasted at only 0.5%, while China faces a growth rate of 4.5% along with challenges in the real estate sector. Vanguard sees rising tensions between momentum and inflated valuations, particularly in U.S. equity ETFs. While high short-term returns remain possible, high valuation levels could be burdensome in the long term. The ETF issuer remains positive on bonds, with projected returns of 4.3% to 5.3% annually for U.S. and non-U.S. global bonds.