Key points

• At the start of the year, global equity markets diverged until US tariff announcements prompted a sharp uptick in volatility.
  
  
• Since then, global equity markets have demonstrated resilience, with European stocks the undisputed winners.
  
  
• In our view, bonds are an attractive asset class for long-term investors, offering more attractive risk-reward compared with equity markets, particularly in the US. 
   

As we look to the second half of the year, we highlight the key drivers of investment performance so far this year and what investors may expect in the months ahead.

Equity markets: The end of US leadership?

Global shares have shown resilience so far this year, but the picture is far from uniform, with US shares down 8% in euro terms and European shares up 9%¹. 

European stocks have been the undisputed winners. Their outperformance can be attributed to several factors, including: attractive valuations, a more dovish central bank policy path and a stimulative German fiscal package.

Meanwhile, currency has been an important driver of returns. A weaker US dollar (since the beginning of the year, the US dollar has experienced a notable decline against most major currencies) has also impacted the performance of US equities from the perspective of a GBP or EUR investor.

Bond markets: Navigating high yields and fiscal pressures

Bond markets have faced some headwinds from yields rising amid concerns over fiscal sustainability. Projected annual US deficits in the range of 6%–7% of GDP (with an increasing share of the deficit being used to cover debt-servicing costs) have raised concerns among investors about long-term sustainability.

Meanwhile, 10-year German bunds and gilt yields are high, driven by inflation concerns and increased government borrowing.

Over the longer term, we foresee rates remaining above the level of inflation in much of the world. This makes bonds an attractive asset class for long-term investors, who may nonetheless need to become accustomed to reaping returns from reinvesting interest payments at higher rates rather than from price appreciation.

Asset allocation and the road ahead

The equity risk premium in the US is now close to zero, a level seen only twice in the past 70 years. Stocks are more expensive compared with bonds than they have been in nearly 25 years. And credit spreads are compressed.

While global financial markets have shown resilience in 2025, the picture is far from homogenous. Market volatility remains elevated, exacerbated by recent geopolitical events.

Today more than ever, diversification is not just a free lunch. It is the option least likely to cause indigestion.

Our economic outlooks

United States

An improved outlook despite continued policy uncertainty

The US economy has remained resilient despite significant economic policy uncertainty through the first half of 2025. The labour market has cooled but remains stable, and inflation data has come in better than expected.

The recent de-escalation of tariff policy with China was a pivotal development, and we have made meaningful, positive revisions to our outlook as a result. Overall, we see a less stagflationary impact to the economy and view the risk of further escalation in trade policy as having been materially reduced. We expect the focus to shift towards fiscal policy in the second half of the year.

US Federal Reserve (Fed) interest rate policy is likely on hold for now but we anticipate that the Fed will be able to make two more rate cuts later this year in this environment.

United States economic forecasts

Euro area

A rising risk of an inflation undershoot

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 fiscal package and greater defence spending throughout the EU are more of a 2026 story.

We forecast just one more rate cut this cycle, likely to be in September, 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 towards further easing.

Euro area economic forecasts

United Kingdom

Softening labour market paves the way for more rate cuts

We continue to expect GDP growth of around 1% in 2025 and 2026. Relative to our expectations at the start of the year, activity was stronger than anticipated in the first quarter. We expect slower growth from the second quarter onwards, as uncertainty weighs on household and corporate spending.

Employment growth is softening materially, due partly to the government raising taxes for employers in April 2025.

We continue to expect the Bank of England to maintain a quarterly cadence of monetary policy easing that would put the bank rate at 3.75% at the end of 2025. 

United Kingdom economic forecasts

Japan

Global trade uncertainty warrants cautious stance by BoJ

Domestic demand was robust in the first quarter, with private consumption increasing for the fourth consecutive quarter, but real GDP growth turned negative due to a deterioration in net exports.

Looking ahead, we expect private consumption to remain resilient. Wages continue to rise steadily, and as inflation—primarily driven by food prices—gradually stabilises, consumer confidence and real incomes are poised to improve.

We have lowered our expectations for the year-end policy rate from 1% to 0.75%, suggesting the Bank of Japan (BoJ) will raise the rate target once more this year. Inflation remains above the BoJ’s target, though risks to both growth and inflation skew to the downside owing to tariff developments.

Japan economic forecasts

China

Deflationary pressure persists even as tariff shocks subside

China’s economy has maintained steady growth so far in 2025, with key activity data for the first five months remaining robust. Despite higher US tariffs, exports have remained resilient. However, tariff-related uncertainty remains elevated and continues to pose downside risks to growth.

We recently raised our 2025 GDP growth forecast for China to 4.6% from 4.2%, primarily due to the de-escalation of trade tensions with the US. As tariff shocks subside, policymakers are likely to adopt a more measured and reactive approach, with a modest policy rate cut of 10 basis points to 1.3% expected by year-end (basis point is one-hundredth of a percentage point). 

China economic forecasts

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 31 May 2025.

Our 10-year annualised nominal return projections, expressed for local investors in local currencies, are as follows².

¹ Returns based on the MSCI USA Index for US shares and the MSCI EMU Index for European shares, denominated in EUR as at 30 June 2025. 

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.

IMPORTANT: The projections or 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 US and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, US 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.

The primary value of the VCMM is in its application to analysing potential client portfolios. VCMM asset-class forecasts—comprising distributions of expected returns, volatilities, and correlations—are key to the evaluation of potential downside risks, various risk–return trade-offs, and the diversification benefits of various asset classes. Although central tendencies are generated in any return distribution, Vanguard stresses that focusing on the full range of potential outcomes for the assets considered, such as the data presented in this paper, is the most effective way to use VCMM output.

The VCMM seeks to represent the uncertainty in the forecast by generating a wide range of potential outcomes. It is important to recognise that the VCMM does not impose “normality” on the return distributions, but rather is influenced by the so-called fat tails and skewness in the empirical distribution of modelled asset-class returns. Within the range of outcomes, individual experiences can be quite different, underscoring the varied nature of potential future paths. Indeed, this is a key reason why we approach asset-return outlooks in a distributional framework.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Important information

For professional investors only (as defined under the MiFID II Directive) investing for their own account (including management companies (fund of funds) and professional clients investing on behalf of their discretionary clients). In Switzerland for professional investors only. Not to be distributed to the public.

The information contained herein is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.  The information does not constitute legal, tax, or investment advice. You must not, therefore, rely on it when making any investment decisions.

The information contained herein is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

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