2025 outlook at a glance

To help you inform your client discussions and portfolio strategies, we present these quick highlights of the economy and the markets for the year ahead.

Still sound money

As interest rates return toward neutral, we expect them to settle at higher levels than in the 2010s. This environment sets the foundation for solid cash and fixed income returns over the next decade (see table).

U.S. economic resilience

Positive labor supply and productivity developments drove U.S. growth in 2024. Whether these drivers wane or accelerate, coupled with demand factors such as fiscal stimulus, holds the key in 2025.

Growing market tension

The possibility that we are experiencing a valuation-supporting productivity boom must be balanced by the risk that economic developments could expose the vulnerability of stretched equity valuations.

Vanguard’s economic forecasts

Source: Vanguard.

Notes: Forecasts are as of December 2, 2024. For the U.S., GDP growth is defined as the year-over-year change in fourth-quarter GDP. For all other countries/regions, GDP growth is defined as the annual change in GDP in the forecast year compared with the previous year. Unemployment rate forecasts are the average for the fourth quarter of 2025. NAIRU is the nonaccelerating inflation rate of unemployment, a measure of labor market equilibrium. Core inflation excludes volatile food and energy prices. For the U.S., euro area, U.K., and Japan, core inflation is defined as the year-over-year change in the fourth quarter compared with the previous year. For China, core inflation is defined as the average annual change compared with the previous year. For the U.S., core inflation is based on the core Personal Consumption Expenditures Index. For all other countries/regions, core inflation is based on the core Consumer Price Index. For U.S. monetary policy, Vanguard’s forecast refers to the top end of the Federal Open Market Committee’s target range. China’s policy rate is the seven-day reverse repo rate. The neutral rate is the equilibrium policy rate at which no easing or tightening pressures are being placed on an economy or its financial markets.

Vanguard’s outlook for financial markets

Our 10-year annualized nominal return and volatility forecasts are shown below. They are based on the November 8, 2024, running of the Vanguard Capital Markets Model (VCMM). Equity returns reflect a 2-point range around the 50th percentile of the distribution of probable outcomes. Fixed income returns reflect a 1-point range around the 50th percentile. More extreme returns are possible.

In our view, U.S. valuations are elevated but not as stretched as traditional metrics imply. Nevertheless, the likelihood that we are in the midst of a valuation-supporting productivity boom, akin to the mid-1990s, must be balanced with the possibility that the current environment may be more analogous to 1999. In the latter scenario, a negative economic development could expose the vulnerability of current stock market valuations.

Higher starting yields have greatly improved the risk-return tradeoff in fixed income. Bonds are still back. Over the next decade, we expect 4.3%–5.3% annualized returns for both U.S. and global ex-U.S. currency-hedged bonds. This view reflects a gradual normalization in policy rates and yield curves, though important near-term risks remain.

IMPORTANT: The projections and other information generated by the VCMM 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 VCMM are derived from 10,000 simulations for each modeled asset class. Simulations as of November 8. 2024. Results from the model may vary with each use and over time. For more information, see the end of this article.

Source: Vanguard Investment Strategy Group.

Notes: These probabilistic return assumptions depend on current market conditions and, as such, may change over time.

“Coupon wall” and the case for bonds

Higher starting yields cushion bond returns while still allowing investors to take advantage of falling rates. This development, which we refer to as the “coupon wall,” creates an asymmetric and favorable risk/return environment. The long-term case for bonds remains solid.

The U.S. Treasury yield curve is near our estimate of fair value that considers our baseline U.S. economic view of strong productivity growth and a cautious Federal Reserve. Expect the yield curve to stay near current levels and for relatively high coupons to drive returns.

Risks to our outlook hinge on a tug-of-war between productivity gains and potentially in?ationary policy.

If the latter were to materialize, we believe yields across the curve would likely rise and the stock/bond correlation would turn positive as investors demand more compensation for uncertainty.

If productivity gains were to win out, any downward pressure on in?ation would increase the chances that the Fed would cut below 4% and that short-term yields would fall more than long-term yields. We expect long-term yields to remain above 4% due to our strong growth outlook. Further, if yields fall because of a negative shock to demand, bonds should provide a hedge in multiasset portfolios.

We estimate an 81% probability that the Bloomberg U.S. Aggregate Index will provide a positive total return over the next year. Negative returns would result only if yields were to rise enough to breach the coupon wall and induce a capital loss that is larger than the income generated from coupons. We calculate this threshold as around 0.8 to 0.9 percentage points higher than current yields.

Starting yields are much higher than they were three years ago

IMPORTANT: The projections and other information generated by the VCMM 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 May 31, 2021, and November 8, 2024. Results from the model may vary with each use and over time. For more information, please see the end of this article.

Sources: Vanguard calculations, based on data from Bloomberg, as of May 31, 2021, and November 8, 2024.

Notes: The two charts show the one-year-ahead price (y-axis) and income (x-axis) Vanguard Capital Markets Model (VCMM) return projections for the Bloomberg U.S. Aggregate Index as of May 31, 2021, and November 8, 2024. The forecasts are sorted by positive price returns (interest rates fall) and two scenarios under negative price returns (interest rates rise): income returns from coupons offset price losses and income returns do not offset price losses, leading to negative total returns.

All investing is subject to risk, including the possible loss of the money you invest. Past performance is no guarantee of future returns. Diversification does not ensure a profit or protect against a loss. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

U.S. government backing of Treasury or agency securities applies only to the underlying securities and does not prevent share-price fluctuations. Unlike stocks and bonds, U.S. Treasury bills are guaranteed as to the timely payment of principal and interest. Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility. Investments in stocks and bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments. High-yield bonds generally have medium- and lower-range credit-quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit-quality ratings. Although the income from U.S. Treasury obligations held in the fund is subject to federal income tax, some or all of that income may be exempt from state and local taxes.

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.

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