Is Immigration Adding to Inflationary Pressures?

Summary

• Numbers of undocumented, largely low skilled immigrants have surged since 2021.
• This has supported both aggregate supply through higher labour supply, and aggregate demand through higher consumption.
• While unusually low wage growth has accompanied the immigration surge, this has not prevented a stabilization of services inflation, possibly due to business pricing power and migrant demand for housing.
• Compared with other rich countries, the US growth exceptionalism partly reflects the ongoing low skill immigration surge.

Market Implications

• I still expect no Federal Reserve (Fed) cut in 2024, against the market pricing nearly two cuts by end-year.

Undocumented Immigration Surge

In her latest speech, Fed Board Governor Michelle Bowman expressed concerns ‘the inflow of new immigrants to some geographic areas could result in upward pressure on rents.’ Bowman is the latest FOMC speaker to mention immigration, which the Fed sees as a key driver of strong growth in the past few years. Until recently, the Fed also viewed immigration as supporting disinflation, but Bowman and other FOMC members latest public statements shows the Fed assessment is changing.

In this note, I dimension recent immigration flows and assess their impact on growth and inflation.

Undocumented migrant inflows in the US have surged since 2021. This is shown by a surge in Border Patrol apprehensions of ‘inadmissibles’ (Department of Homeland Security terminology, not mine), i.e., people entering the US legally but found ineligible to enter, and in expulsions of undocumented migrants (Chart 1).

Apprehended undocumented migrants and ‘inadmissibles’ can file for asylee status and remain in the US while they wait for their court appearance. This is typically several years in the future as asylum courts have a backlog of over 1.2mn cases, part of an overall backlog of immigration courts of more than 3.5mn cases. Also, 800,000 migrants from countries such as Ukraine, Cuba, and Venezuela have been granted humanitarian parole (i.e., allowed temporary entry into the US and can apply for work authorization).

Border apprehensions are a poor proxy for immigration flows. For instance, a single individual could be responsible for multiple entries; Border Patrol apprehensions are only a subset of illegal entries into the US. Nevertheless, the flows are significant and have led the Congressional Budget Office (CBO) to raise its immigration and population estimates (Table 1).

The inflow of undocumented migrants can be seen in the data. For instance, in the surge in the share of foreign-born workers in the labour force or in the growing disconnect between nonfarm payrolls (NFP) and household (HH) survey employment, with the latter underestimating employment because it is based on the Census Bureau underestimate of migration flows and population growth. The recent rise of the uninsured unemployment rate also suggests an increase in undocumented migrants, reversing a multi-year trend of decline (Chart 2).

These large inflows have raised growth but their impact on inflation is ambiguous.

Surge In Immigration Has Raised Aggregate Supply and Demand

GDP and GDP per worker (measured by NFP since HH survey employment is underestimated) have decoupled since 2022, consistent with a surge in immigration (Chart 3).

Immigration has contributed to both the supply and demand sides of the economy. On supply, as Fed Chair Jerome Powell stressed repeatedly, immigration has contributed to labour supply. It explains why NFPs remain above their pre-pandemic levels and yet unemployment is rising, by contrast with falling unemployment pre-pandemic (Chart 4). In other words, immigration has raised the size of sustainable NFP increases.

The Brookings Institution’s Hamilton Project estimates that immigration has more than doubled to nearly triple the range of sustainable employment growth, but actual NFP growth has outstripped their highest estimates! (Table 2).

Unsurprisingly, this surge in labour supply has had a negative impact on wages. Real wage growth has been much lower during the pandemic recovery than during the recovery from the GFC (Chart 5).

Also, since undocumented migrants tend to be low skilled, and have limited bargaining power due to their precarious legal status, the immigration surge likely explains the disappearance of the pandemic gains of low wage workers relative to high wage workers (Chart 6).

Immigrants have also raised growth through higher consumption (Chart 7). Post-pandemic consumption strength has been impressive, not falling from the unsustainable levels reached after the Biden administration’s exceptional handouts to households.

However, the trajectory of consumption is much more realistic once adjusted for NFP (a proxy for population growth). A decline followed the 2021 surge as households ‘digested’ the 2021 consumption spike (how many laptops, phones, and other durables can one use?). Consumption subsequently recovered in a manner consistent with the pre-pandemic trends. One characteristic of current migrants is that they do not seem to be sending much home, with remittances not increasing much since 2021.

The impact of immigration on housing demand has been strong, as the difference in housing demand and housing demand relative to NFP shows (Chart 8).

While the impact of immigration on growth is positive, the impact on inflation is more ambiguous.

Immigration Could Be Adding to Inflation

Despite the negative impact of immigration on wage growth, disinflation stalled in Q1 2024 (Chart 9). This could reflect a recent stabilization of wage growth, possibly because of a mismatch between immigrants’ skills and labour demand, and possibly because of business pricing power. Profit margins remain close to historical highs as a share of GDI.

Also, housing inflation has stabilized above 5%, which Bowman has stressed may reflect migrant housing demand against supply constrained by years of underinvestment.

Because of limited housing supply and of a skills mismatch, large scale low skill immigration may not be a boon for disinflation.

Does US Exceptionalism Reflect Low Skill Immigration Surge?

Post-pandemic, US growth has outperformed other OECD countries, with the UK and Germany the laggards (Chart 10).

However, once growth is measured on a per capita basis, and US population is based on the most recent CBO estimates (US* on Chart 1), US outperformance is less striking. 2023 per capita growth was higher in Japan than in the US, using either the CBO or International Monetary Fund (IMF) population estimates.

In 2024, the IMF growth forecast implies that even with the CBO population estimates, US per capita growth will outperform Japan, but by a small margin.

Interestingly, once growth is measured on a per capita basis, Canada and Australia become laggards alongside Germany and the UK. This highlights the role of immigration, rather than that of productivity, in driving Canadian and Australian growth.

Market Consequences

Mass undocumented immigration to the US is unlikely to stop soon since migrants are fleeing political and economic instability that is unlikely to improve in the short term.  Furthermore, limiting migrant inflows would require legal changes, for instance on asylum rights, as well as increased spending to reduce immigration courts cases backlog.

A bipartisan immigration bill introduced in the US Senate in February would have dealt with these issues but could not garner enough Republican support. Such a bill is unlikely to be passed until the new Congress is in session in 2025.

Meanwhile, large scale immigration is likely to continue and support growth and possibly hinder disinflation. Sticky inflation in turn is likely to prevent the Fed from cutting in 2024.  My view compares with markets now pricing almost two cuts by December.

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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)