The gradual removal of policy support and stimulus implemented to combat the economic downturn triggered by the COVID-19 pandemic poses a new challenge for policymakers and a source of risk for financial markets, according to Vanguard Economic and Market Outlook for 2022: Striking a Better Balance.

The global economic recovery is likely to continue, albeit at a slower rate. Health outcomes will remain important given the emergence of the Omicron variant, but the outlook for macroeconomic policy will be more crucial. Labor markets will continue to tighten, with several major economies, led by the U.S., quickly approaching full employment.

Our outlook focuses on these key themes:

Inflation will be lower but stickier. We anticipate that supply/demand frictions will persist well into 2022 and keep inflation elevated. But it is highly likely that increases in the prices of goods and services will slow during the year, even amid persistent wage gains.

How long will inflation last?

Core CPI, year-on-year change

6% 5 4 3 2 1 0 -1





Notes: Data and Vanguard forecasts are for year-on-year percentage changes in the core Consumer Price Index, which excludes volatile food and energy prices. Actual inflation is through September 2021 for the U.S., U.K., and China and through October 2021 for the euro area. Vanguard forecasts are presented thereafter.
Sources: Vanguard calculations, using data from Bloomberg and Refinitiv.

The risk of a policy misstep has increased. Central bankers will have to strike a delicate balance between controlling inflation expectations and supporting full employment as they withdraw exceptionally accommodative policies. In the United States, the Federal Reserve may have to raise rates higher than some expect, perhaps to at least 2.5%.

Rising rates won’t upend bond markets. Rising inflation and policy normalization mean that the short-term interest rates targeted by the Fed, the European Central Bank, and other developed-market policymakers are likely to rise. But rising rates are unlikely to produce negative long-term total returns in bond markets. We expect annualized U.S. bond returns of 1.4%–2.4% over the next decade.

Equities face a challenging environment. Low bond yields, reduced policy support, and stretched valuations in some markets form a challenging backdrop for equities. We are projecting the lowest 10-year annualized returns for global equities since the dot-com bubble of the early 2000s. For example, we expect U.S. equity returns of 2.3%–4.3% per year.

U.S equities have not been this overvalued since the dot-com bubble

Cyclically adjusted price/earnings ratio

50 40 30 20 10 0
Fair-value CAPE +/-0.5 standard error
CAPE for the S&P 500 Index
Historical average
Dot-com bubble









Notes: The U.S. fair-value CAPE is based on a statistical model that corrects CAPE measures for the level of inflation and interest rates. The statistical model specification is a three-variable vector error correction, including equity-earnings yields, 10-year trailing inflation, and 10-year U.S. Treasury yields estimated over the period January 1940 to September 2021. Details were published in the 2017 Vanguard research paper Global Macro Matters: As U.S. Stock Prices Rise, the Risk-Return Trade-Off Gets Tricky (Davis, 2017). A declining fair-value CAPE suggests that higher equity risk premium (ERP) compensation is required, while a rising fair-value CAPE suggests that the ERP is compressing.
Sources: Vanguard calculations, based on data from Robert Shiller’s website, at, the U.S. Bureau of Labor Statistics, the Federal Reserve Board, Refinitiv, and Global Financial Data, as of September 30, 2021.

Source: Vanguard Capital