Men working on a building

In brief

  • Migration into the U.S. has surged, accounting for the majority of population growth in recent years and likely the bulk of employment growth in recent months.
  • This year’s rise in bond yields reflects stronger growth and stickier inflation, which probably both owe in part to migration. The likely persistence of these effects has caused us to remove duration overweights.
  • Most of the upside surprise in recent months’ inflation data owes to idiosyncratic drivers, some of which are related to migrant demand. However, over the longer term we expect the effects of migration will be more clearly disinflationary. It would be difficult for inflation to reaccelerate meaningfully without significant wage pressure driven by labor market tightening.
  • Our proprietary U.S. Labor Slack Tracker finds that labor markets are only about as tight as they were in 2019, thanks in large part to a glut of labor supply from migration. Over the next year, reduced wage pressures could in turn require less restrictive monetary policy and potentially help prolong the business cycle.

Many of the U.S. macroeconomic narratives of the last year – surprisingly robust growth, a mixed picture for inflation (underlying inflationary pressures are fading, but idiosyncratic pressures have been persistent) – may be largely explained by surging migration. For multi-asset investors, the implications are significant.

Government estimates show the extent of the surge. In 2019, the U.S. Congressional Budget Office (CBO)  projected that net immigration would hit 1.0 million in 2023. The agency’s latest estimates put net immigration for 2023 at 3.3 million, or 1% of the U.S. population in a single year.

These updated migration estimates are anchored on primary data from Customs and Border Protection, which show encounters along the southwest border start to take off in early 2021. The pace picked up over the second half of 2023 when encounters along that border topped 300,000 per month. That compares to a pre-surge monthly pace of roughly 60,000. Most of the people encountered have been paroled into the U.S. while they await asylum hearings that may be years away given a backlog of over a million cases.

If migration into the U.S. took off in 2021, why are we only now only seeing its economic effects? In hindsight, migration probably explains more of last year’s strong robust growth and inflation normalization than previously appreciated. There are a few reasons, though, why this effect might be more dramatic now.

First, delays in work authorization (including a statutory six-month delay) mean that many earlier arrivals, especially from the bigger 2H 2023 surge, are likely just now entering the labor market or switching from undocumented to legal employment. Further, since this massive new supply of migrant labor tends to be lower skilled and often non-English-speaking, there may have been more fundamental delays in matching them to jobs. It has taken time for migrant labor supply to diffuse across the country to regions with more unmet demand, and for businesses to find opportunities to utilize the new supply of labor.

We see the clearest direct impact of rising migration in the acceleration of potential economic growth and job gains. Most migrants want to work;  foreign-born labor force participation tends to be about 4%-5% above domestic-born, according to BLS data. We estimate the addition of migrants to the labor force has increased in the current sustainable pace of payroll expansion by about 110,000 per month. More migrant workers also increase potential GDP growth by about 0.2% this year.

For markets, the other important effect of migration is on inflation. In our view, the longer-run effects of migration will be mostly disinflationary given the contributions to labor supply. Already, the boost in migrant labor supply partly explains why the unemployment rate as of March 2024 is about 0.4 percentage points (ppts) higher than it was trending a year earlier (despite extraordinarily strong payroll growth). More slack means less wage pressure, especially if migrant wages are lower than prevailing rates, which is ultimately disinflationary.

The effects of migration, however, aren’t all on the supply side and they aren’t all disinflationary. Migrants also contribute to demand and increased demand can push prices higher.  We see one clear example  in housing: Many migrants are working in construction and will ultimately contribute to the supply of new units, but they need housing now. Migrants’ demand for housing—probably about a third of the current robust 1.5-million-unit annual pace—explains why vacancy rates remain low, why market prices keep climbing from elevated levels, and, in part, why official shelter price inflation remains so sticky.

Similarly, each new migrant worker needs new tools, which could drive up demand for certain capital goods faster than supply can expand. When considering such mismatches in supply and demand, we should also consider that excess demand shocks tend to drive up prices more than excess supply shocks drive prices down.

In the longer run, though, as markets adjust, we think supply factors will outweigh demand factors. This is partly because many migrants will likely repatriate much of their incomes back home. In addition, low-wage migrant workers might depress wage gains for other low-wage workers.

A broader view of labor market slack

As we see it, most of the upside surprise in recent months’ inflation data owes to idiosyncratic drivers such as greater housing demand. It would be difficult for inflation to reaccelerate meaningfully without significant wage pressure, which is in turn driven by low levels of labor market slack.

But labor market slack is tougher to measure these days. One consequence of migration has been to make certain government statistics such as the U-3 unemployment rate less accurate.

Our new U.S. Labor Slack Tracker (Exhibit 1) aims to provide a more comprehensive view of labor market utilization. The tracker draws on 15 measures spanning un(der)employment, job openings, hours worked, and voluntary and involuntary separations. (It does not track the pace of job gains or wage pressure.) 

Most such measures suggest that slack, though still tight, has been increasing slightly over the last several months. The median measure suggests peak tightness in Q3 2022. Since then, despite robust job gains, labor slack has been increasing, reaching pre-pandemic (end of 2019) levels in Q4 2023.

This broader set of measures also suggests labor markets are slightly less tight than the levels implied by U-3 unemployment. Most notably, the rates of JOLTS quits and of job leavers have dropped in recent months. In addition, measures of hours worked, including manufacturing overtime and the average of all private employees, remain low, although  these measures may be impacted by structural changes. All these measures suggest some likely degree of labor market underutilization.

To be sure, two outlier measures send a countersignal, but we would downplay both of them. First, the jobs-workers gap, actual employment plus JOLTS job openings minus the labor force, has significantly loosened from its extreme tights in 2022, puzzlingly lagging other measures. However, the implied difficulty in finding workers is not mirrored in other surveys.

Second, the labor force participation rate of “prime age” (25-54) males also implies labor market tightness. This rate rises cyclically as labor markets tighten, but it has also undergone a secular downtrend since the 1950s. We think that the current participation rate, rather than signaling tightness relative to a continued downtrend – as our tracker conservatively assumes – instead implies that the secular downtrend has abated.

As mentioned, our Labor Slack Tracker indicates that the U.S. labor market is roughly as loose as it was in 2019. At that time, labor markets were relatively tight on a historical basis, but not when one considered that worker compensation as measured by the BLS’ Employment Cost Index (ECI) stood at a quiescent 2.7% y/y. Today, even with strong labor demand, we do not see wages accelerating as long as labor slack remains around current levels. A sharp disruption in migrant labor supply would pose the biggest risk to this view, though it seems a remote prospect before the November election.

Asset class implications

How might the Federal Reserve (Fed) assess the impact of migration? In the near term, the consequences have evidently skewed hawkish for monetary policy. Migrants’ demand, especially for capital investment – from housing to work tools – has likely contributed to more idiosyncratic inflation components such as rent, as well as an acceleration of real potential growth. We note that an increased need to fund capital investment may also contribute to higher equilibrium interest rates (r*).

In the next several months, however, these idiosyncratic factors are likely to fade as a relative glut of lower-income labor could help keep a lid on wage inflation. The fading of underlying inflation pressures amid robust growth should ultimately help the U.S. economy achieve a soft landing and potentially prolong the business cycle. That view supports our preference for risk assets including U.S. equity and shorter-duration credit. 

Ultimately, fading inflation should also require less restrictive monetary policy – we expect that the Fed will be able to deliver one or two rate cuts this year beginning in the second half. However, since that easier policy will likely be offset by higher neutral policy rates, our view on duration remains neutral.

Beyond the U.S., we also prefer Japanese equities given prospects for reflation and corporate governance reforms. Within duration, we prefer a mix of European and U.S. government bonds.