Key points

• US equities are reasserting their dominance after early outperformance by global equities.

• Europe’s year-to-date equity gains owe more to valuation changes than to earnings.

• Fiscal sustainability has given way to cyclical concerns for investors in US bonds.

Compared with their European counterparts, investors in the US have expressed their confidence recently. US stocks have ridden earnings growth to close a 2025 performance gap with European stocks, while long-term US borrowing costs have fallen on rate-cut hopes, despite persistent fiscal challenges.

Global ex-US equities notably have outperformed their tech-heavy US counterparts year to date. However, that performance gap has largely disappeared in recent months, once US dollar depreciation is accounted for. Much of the gains by US equities have occurred since April, when concerns about US tariffs peaked.

Market developments have become familiar: The tech- and AI-heavy Nasdaq Composite Index has outperformed the S&P 500 Index. The latter has, in turn, outperformed the “old economy” Dow Jones Industrial Average. Gains have been driven by earnings growth that has exceeded expectations, with tech and AI companies continually expanding profit margins.

On the other hand, in Europe—which accounts for about 40% of the global ex-US equity market—corporate earnings appear poised to decline for the year. This is a letdown for a year that started with expected earnings growth of 8%. It also means that much of the (still impressive) return accrued to European equity holders this year is attributable to multiple expansion rather than organic profitability growth. Year-to-date to 15 September, European equities returned 11% in local currency terms and 26.5% in US dollars as measured by the Euro Stoxx 50 Index, versus 12.5% for the S&P 500 Index.

As the equity returns in the US and Europe converge (ignoring the effects of currency for comparative purposes), important questions are arising for global ex-US equities. For example, has the prospect of higher earnings growth for 2026 (thanks partly to an anticipated increase in fiscal spending) already been priced in? Additionally, will such earnings growth materialise against a backdrop of slow economic growth and fiscal sustainability concerns? And will these potential factors allow for further multiple expansion?

Bond markets offer their own conundrums. In the US, concerns about a potential cyclical slowdown appear to have superseded important longer-term matters, including rising structural deficits and their associated inflationary risks. Anticipation of the US Federal Reserve (Fed) further cutting interest rates (following its 25 basis point (bps) cut on 17 September) has accompanied the decline across the US yield curve in recent weeks.

Meanwhile, fiscal sustainability concerns are driving up long-term yields in other economies, notably the UK, France and Japan. These concerns have been brought into sharper focus by recent prime minister transitions in France and Japan.

Three countries where long-term yields reflect sustainability concerns

Sources: Vanguard calculations, using data from Bloomberg, as at 12 September 2025.

For these economies, a downside scenario involves a downward spiral of fiscal dynamics, with markets demanding a greater premium due to sustainability concerns - thus exacerbating the concerns, which would shrink fiscal capacity and potentially weigh on growth. It will be worth monitoring these countries in the coming months to see how the issues are resolved. This matters not only for their own economies and markets, but also for the lessons that may be transferable to other advanced economies - including the US, where investors are taking a hiatus from their fiscal sustainability concerns.

Our economic outlooks

United States

Labour market takes on renewed focus at the Fed

The subdued job creation observed in recent labour market reports has shifted monetary policy sentiment towards a renewed focus on the employment side of the Fed’s dual mandate of ensuring price stability and promoting maximum sustainable employment. We expect mandate tensions to be a continuing factor as inflation accelerates amid tariff-related pass-through to consumer prices. 

The number of monthly job creations required to keep the unemployment rate steady—the breakeven rate—has shifted downward from roughly 150,000 a year ago towards a level we anticipate being near 50,000 by year-end. Domestic demographics and a slowdown in immigration continue to be headwinds to labour force growth. We expect the unemployment rate to soften to 4.5% by year-end. More broadly in the economy, we continue to see growth slowing but still maintaining healthy momentum.

It was in this environment that the Fed announced a quarter percentage point interest rate cut at its 17 September meeting, lowering the federal funds rate to a range of 4.0%-4.25%. Despite the move, we expect the Fed to remain cautious going forward, given the great deal of uncertainty and the Fed’s desire to be data-dependent. Overall, we see the economy tracking in-line with our expectations of a softening labour market, with 1.4% GDP growth and 3.1% core inflation by year-end. 

United States economic forecasts

Notes: GDP growth is defined as the fourth-quarter-over-fourth-quarter change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2025. Core inflation is the year-over-year percentage change in the Personal Consumption Expenditures (PCE) price index, excluding volatile food and energy prices, as of December 2025. Monetary policy is the upper end of the Fed’s target range for the federal funds rate at year-end.

Source: Vanguard.

United Kingdom

Fiscal tightening in the autumn budget likely to weigh on UK growth

The UK economy remains fundamentally fragile despite a stronger-than-expected GDP print in the second quarter. GDP grew by 0.3% quarter-on-quarter, outperforming consensus expectations. However, this upside surprise was largely driven by a temporary spike in government-related expenditures, while consumer spending remained subdued. In response, we recently mechanically upgraded our 2025 growth forecast by 0.2 percentage points to 1.3%, though we continue to expect the economy to remain weak in the second half of the year.

The UK chancellor of the exchequer’s £10 billion fiscal headroom is likely to be wiped out ahead of the autumn budget, driven by policy developments and expected downgrades to near-term and trend growth by the Office for Budget Responsibility. Further tightening in fiscal policy appears inevitable and is a key reason for our below-consensus 2026 growth forecast of around 0.8%.

Inflation has been stickier than expected over the last few months. We anticipate that unfavourable comparisons to year-earlier numbers and spikes in regulated price changes will push the Consumer Prices Index (CPI) toward 4% year over year in the next few months. As such, we have increased our forecasts for year-end 2025 headline inflation to 3.8% and core inflation to 3.7%.

The near-term outlook for the Bank of England (BoE) has become more hawkish. Payroll data revisions suggest the labour market is softening but not collapsing, and the central bank has signaled a renewed focus on second-round effects from elevated inflation expectations. That leads us to expect that the BoE won’t cut the bank rate further this year — leaving it at its current rate of 4% at year-end 2025. However, with an almost certain tightening of fiscal policy in the autumn budget, we foresee the BoE cutting the bank rate to 3.25% by the end of 2026..

United Kingdom economic forecasts

Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2025. Core inflation is the year-over-year change in the Consumer Prices Index, excluding volatile food, energy, alcohol and tobacco prices, as of December 2025. Monetary policy is the Bank of England’s bank rate at year-end.

Source: Vanguard.

Euro area

ECB to cut only once more this cycle, if at all

We continue to expect euro area growth to remain slightly below trend, tracking around 1% in both 2025 and 2026. GDP grew by 0.1% in the second quarter, having increased by 0.6% in the first quarter with the supportive effects of tariff frontrunning. Softer global activity, elevated policy uncertainty and higher tariffs are likely to weigh on demand in the second half of the year.

Following the European Union’s recent trade agreement with the United States, the effective tariff rate on EU exports is set to rise from the current level of 13% to a range of 15%–17% by year-end. We expect Germany’s fiscal package and increased EU-wide defense spending to support growth from 2026 onward.

Inflation continues to hover around 2%, with services inflation dropping to its lowest reading since early 2022. We expect headline and core inflation to end 2026 below 2%. The European Central Bank (ECB) held its deposit facility rate steady at 2% at its 11 September meeting. We forecast just one more rate cut in this cycle, which would leave the policy rate at 1.75% at year-end.  

Euro area economic forecasts

Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2025. Core inflation is the year-over-year change in the Harmonized Indexes of Consumer Prices, excluding volatile energy, food, alcohol and tobacco prices, as of December 2025. Monetary policy is the European Central Bank’s deposit facility rate at year-end.

Source: Vanguard.

Japan

Bank of Japan still on track to hike rates

Japan’s GDP growth surprised to the upside in the second quarter, despite US tariff threats, which should allay any fears the Bank of Japan (BoJ) may have of a sharp economic slowdown. GDP grew by 0.5% in the quarter and by 1.7% year over year.

Private capital spending has been a notable growth driver, and consumption continues to recover despite elevated inflation. The impact of US tariffs on the real economy has been limited so far. Net exports contributed 0.3 percentage points to headline growth, which may reflect export frontloading. Corporate sentiment is additionally showing signs of recovery, as agreement with the US over tariffs has significantly reduced uncertainty.

Although the impact of earlier shocks such as elevated import prices and food costs is expected to fade, underlying inflationary pressures remain intact. These are driven by persistent structural labour shortages, which are exerting upward pressure on wages and reinforcing a virtuous cycle between wage growth and price increases.

We expect the BoJ to proceed with its monetary policy normalisation, gradually moving from its current 0.5% rate target toward a neutral policy stance closer to 1% as economic conditions evolve in line with its forecasts.

Japan economic forecasts

Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2025. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile fresh food prices, as of December 2025. Monetary policy is the Bank of Japan’s year-end target for the overnight rate. 

Source: Vanguard.

China

Growth momentum likely to moderate despite stock rally

Growth momentum is likely to moderate in September despite a 13% stock market rally in the third quarter through 10 September. We expect export resilience to continue in the near term, albeit moderately, as tariff uncertainty fades out. 

With the economy steadily on track for the year and a lower comparative base for the third quarter, we see limited urgency for the government to take stimulative measures soon. We expect growth to slow in the second half, owing to the payback of consumption frontloading, a still-ailing property sector and elevated global uncertainty.

Given these developments, we foresee prevailing deflationary pressures continuing for the rest of 2025. The path toward broader reflation is expected to be gradual and bumpy.

China economic forecasts

Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2025. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, as of December 2025. Monetary policy is the People’s Bank of China’s seven-day reverse repo rate at year-end.

Source: Vanguard.

Asset-class return outlook

Vanguard has updated its 10-year annualised outlooks for broad asset class returns through the most recent running of the Vanguard Capital Markets Model® (VCMM), based on data as at 30 June 2025.

Our 10-year annualised nominal return projections, expressed for local investors in local currencies, are as follows¹.

¹ The figures are based on a 2-point range around the 50th percentile of the distribution of return outcomes for equities and a 1-point range around the 50th percentile for fixed income.