Key points

• The US dollar has fallen more than 9% this year on the back of a global reconsideration of dollar-denominated assets amid trade tensions, fiscal concerns and institutional uncertainty.
  
  
• US dollar depreciation has driven global ex-US equity outperformance. Recent shifts and the speed at which they occurred underscore the value of global diversification.
  
  
• In the long term, the US dollar appears fairly valued. While we expect global ex-US equities to outperform US equities, gains are likely to come from corporate fundamentals rather than dollar weakening.
   

For the past three years, the US dollar stood tall—overvalued and seemingly defying its fundamental gravity. But in recent months, it has come back down to a level that we assess to reflect long-term fair value compared with a basket of developed-market currencies. 

The US dollar has retreated to fair-value territory

Notes: The chart shows our fair-value estimate for the US dollar against an equity market capitalisation-weighted basket of the euro, Japanese yen, British pound, Canadian dollar and Australian dollar. The fair-value estimate is based on the part of exchange-rate movements that can be explained through differentials in relative economic strength, measured by productivity (GDP per capita at purchasing power parity) and long-term real rates.

Sources: Vanguard calculations, based on data from Refinitiv and the International Monetary Fund, as at 30 June 2025.

With the dollar now firmly back within our estimated fair-value range, we view the risks as more balanced than at any time during the last three years. Over the short term, an easing of trade tensions and greater certainty around US policy may lead to dollar appreciation. Alternatively, a continued reconsideration of dollar-denominated assets among global investors could result in further declines. Longer term, however, we see higher US productivity and persistently higher (but sustainable) US interest rates as supportive of the current dollar valuation.

The shift reinforces the case for global diversification. With US equity valuations still stretched and other markets offering more historically grounded return prospects, spreading risk across regions remains a cornerstone of a sound long-term strategy.¹

Our economic outlooks

United States

A resilient first-half performance

The US economy has remained resilient despite significant economic policy uncertainty through the first half of 2025. The labour market has gracefully decelerated so far this year and remains in a balanced position. It has averaged roughly 150,000 jobs per month over both the previous three months and the last year, highlighting an uncommon period of stability. We presently expect a modest boost to growth in 2026 in light of these circumstances, with deficit-impact concerns remaining a key focus of market participants.

Inflation data has continued to come in lower than expected. Despite a sharp rise in announced tariff rates, substantial import frontrunning early in the year has muted the inflationary impact and will likely continue to do so throughout 2025. However, the June Consumer Price Index report indicated accelerated increases in core goods prices, suggesting that companies are beginning to pass tariff costs on to consumers. We expect a modest pickup in core goods inflation in the second half and see the core Personal Consumption Expenditures price index ending 2025 around 3% year-over-year.

It is worth noting that the frontrunning effect is not a free lunch—it has muted the near-term impact of increased tariffs but will modestly prolong their effects into 2026. 

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 price index, excluding volatile food and energy prices, as of December 2025. Monetary policy is the upper end of the Federal Reserve’s target range for the federal funds rate at year-end.

Source: Vanguard.

Euro area

Germany’s fiscal stimulus bolsters growth outlook

We expect growth in the euro area to track around 1% in both 2025 and 2026, slightly below trend. Softening global activity, driven partly by elevated policy uncertainty and higher tariffs, is expected to weigh on final demand. The tailwinds from Germany’s recent fiscal package and greater defence spending across the European Union are more of a 2026 story. Short-term implementation risks surrounding German fiscal policy have now receded. ​

The chances of undershooting the 2% inflation target set by the European Central Bank (ECB) are rising. Both wage growth and services inflation are now falling meaningfully. And a weakening global growth outlook, coupled with a stronger euro and lower energy prices, points to further disinflation ahead. ​

We forecast just one more rate cut this cycle, which would leave the policy rate at 1.75%, a touch below our estimate of neutral (2–2.5%). The balance of risks is skewed toward further easing.​

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.

United Kingdom

Fiscal policy set to tighten further

The UK chancellor of the exchequer’s previous fiscal headroom (roughly £10 billion) is likely to be wiped out ahead of the Autumn Budget, driven by policy developments and the Office for Budget Responsibility’s likely downgrades to near-term and trend growth. An intensifying fiscal drag has long been our view and is the primary reason for our below-consensus growth forecast of 0.8% for 2026.

With the labour market and wage inflation showing signs of cooling, we expect services inflation—which has broadly tracked 5% in recent months—to soon follow suit. These developments, coupled with the prospect of fiscal policy being tightened further in the Autumn Budget and long-term inflation expectations being well anchored, should convince the Bank of England (BoE) that inflationary pressures will subside despite current stickiness.​

We continue to expect the BoE to maintain a quarterly cadence of easing. This would put the bank rate at 3.75% at the end of 2025 and at 3.25% by mid-2026.​ We also expect the BoE to set its next 12-month plan for reducing its gilt holdings at £75 billion in September 2025.​

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.

Japan

BoJ adopts cautious stance amid uncertainty, capital market concerns

Tariff developments have triggered a sharp deterioration in consumer and corporate sentiment, suggesting capital expenditure momentum will fade in the coming quarters. Exports remained relatively firm in the April-May period despite US tariff policy, with declines in auto exports to the US partially offset by exports to Asia and frontloaded tech exports.

We anticipate that the Bank of Japan (BoJ) will not make any changes at its July meeting to its current policy rate target of 0.5%. Nevertheless, we expect the BoJ will stick to its policy-normalisation cycle, as domestic inflation momentum remains well above target and wage-price dynamics are strengthening. We foresee the policy rate target ending the year at 0.75%.

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

After solid first-half growth, a slowdown in momentum is likely

China’s economy demonstrated resilient growth in the second quarter, with real GDP expanding by a stronger-than-expected 5.2% year over year and a solid quarter-over-quarter increase of 1.1%. Given this strength, we have upgraded our full-year China GDP forecast from 4.6% to 4.8%. Growth was primarily underpinned by robust exports and frontloaded policy easing. A goods trade-in programme has boosted consumption, while accelerated policy stimulus has supported economic growth.

Exports have remained resilient in the face of US tariffs, supported by frontloading and the rerouting of shipments. We expect external policy volatility to subside in the coming months, offering temporary relief to the export sector. Peak tariffs may be behind us, but headwinds remain, with the US average tariff rate on China higher now than it was at the beginning of the year.

We expect China’s growth momentum to moderate in the second half of the year. Positive impulses from frontloaded exports are likely to fade, while several sources of headwinds will weigh on demand.

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, compared with the previous year. 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 follows².

¹ Vanguard’s 10-year outlook assigns a 66% probability to global ex-US equities outperforming US equities, driven by valuation and earnings growth differentials.

² 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.