Our Global Head of Fixed Income and Public Policy Research, Michael Zezas, joins our Chief U.S. Economist, Michael Gapen, to discuss the possible outcomes for President Trump’s immigration policies and their effect on the U.S. economy.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Public Policy Research.

Michael Gapen: And I'm Michael Gapen, Chief U.S. Economist for Morgan Stanley.

Michael Zezas: Our topic today: President Trump's immigration policy and its economic ramifications.

It's Friday, February 14th at 10am in New York.

Michael, migration has always been considered an important feature of the global economy. In fact, you believe that strong immigration flows were an important element in the supply side rebound that set the stage for a U.S. soft landing. If we think back to the time before President Trump took office almost a month ago, how would you categorize immigration trends then?

Michael Gapen: So, we saw a very sharp increase in immigration coming out of the pandemic. I would say, if you look at longer term averages, say the 20 years leading up to the pandemic, normally we'd get about a million and a half immigrants, per year into the United States. A lot of variation around that number, but that was the long-term average.

In 2022 through 2024, we saw immigration surge to about 3 million per year. So about twice as fast as we saw normally. And that happened at a very important time. It allowed for very significant and rapid growth in the labor force, just at a time when the economy was emerging from the pandemic and demand for labor was quite high.

So, it filled that labor demand. It allowed the economy to grow rapidly, while at the same time helping to keep wages lower and inflation starting to come down. So, I do think it was a major underpinning force in the ability of the U.S. economy to soft land after several years of above target inflation.

Michael Zezas: Got it. And so now, with a second President Trump term, are we set up for a reversal of this immigration driven boost to the economy?

Michael Gapen: Yeah, I think that's the key question for the outlook, and our answer is yes. That if we are going to significantly restrict immigration flows, the risk here is that we reverse the trends that we've just seen in the previous year.

So, I certainly believe one of the main goals of the Trump administration is to harden the border and initiate greater deportations. And these steps in my mind come on the back of steps that the Biden administration already took around the middle of last year that began to slow immigration flows.

So yes, I do think we should look for a reversal of the immigration driven boost to the economy. But Mike, I would actually throw this question back to you and say on the first day of his presidency, Trump issued a series of executive orders pertaining to immigration. Where are we now in that process after these initial announcements? And what do you expect in terms of policy implementation?

Michael Zezas: Well, I think you hit on it. There's two levers here. There's stepped up deportations and removals and there's working with Mexico on border enforcement. Things like the remain in Mexico policy where Mexico agrees to keep those seeking asylum on their side of the border; and to facilitate that, they've stepped up their military presence to do that.

Those are really kind of the two levers that the U.S. is pushing on to try and reduce the flow of migrants coming into the U.S. Still to be determined how much these actually have an impact, but I think that's the direction of policy travel.

Michael Gapen: And are there any catalysts specifically that you're watching for? I mean, recently the administration proposed tariffs on Mexico and Canada around border control, but those have been delayed. Is there anything on the horizon we should look for this time around?

Michael Zezas: Yeah. So obviously the president tied the potential for tariffs on Mexico and Canada to the idea that there should be some improvement on border enforcement. It's going to be difficult for investors, I think, to assess in real time how much progress has been made there. Mostly it's a data challenge here. There are official government statistics which have a good amount of detail about removals and folks stopped at the border and demographics in terms of age and, and whether or not they were working. That might really kind of help us piece together the story in terms of whether or not there's going to be future tariffs – and Michael, probably for you, to what extent there's an impact on the economy if folks are already in the labor force.

But that data is on a lag, it'll be really difficult to tell what's happening now for at least several months. Maybe we're going to get some hints about what's going on for comments coming in earnings calls, for example, from companies that deal in construction and food service and hospitality. But I don't know that those anecdotes would be sufficient to really draw substantial conclusions. So, I think we're a bit in a fog for the next couple months on exactly what's happening.

But based on all this, Michael, what's your outlook for immigration this year and beyond?

Michael Gapen: Yeah, so we, as I mentioned, we were getting about 3 million immigrants per year between 2022 and 2024; long run averages before the pandemic were more like a million and a half a year. Our outlook is that immigration flows should slow below pre- COVID averages to about 1 million this year and about 500,000 in 2026. And again, that would be the well below the long run average of about a million and a half per year.

Now, as you mentioned, understanding these flows in real time is hard and there's a lot of uncertainty around this and how effective policies may be. So, I think people should consider ranges around this baseline, if you will. On one hand, we could see a reduction in unauthorized immigration replaced by more authorized immigration. So maybe there's a benign scenario where immigration slows back to its one and a half million per year. But it's more through legal and formal channels than unauthorized channels.

Alternatively, it could be the case that some of the policies, you mentioned in terms of, say, stepped up deportations or other measures, and maybe there's a chilling effect. That there's just like an externality on immigration behavior. And in fact, we slow maybe to about 500,000 this year and see a decline in about 250,000 next year.

So, I think there's a lot of uncertainty about it. We think immigration slows below its longer run averages, which would represent a major shift from what we've seen over the last three years.

Michael Zezas: Got it. So, lots of crosscurrents here, about how the actual labour supply is impacted. But bottom line, if we do arrive at a point where there’s a significant reduction in immigration, what’s the expectation about what that means for the U.S. economy?

Michael Gapen: Yeah, so a lot of cross currents here. Number one, I think with a high degree of confidence, we can say reduced immigration should lead to slower potential growth, right? So, a slower growth in the labor force should mean slower growth in trend hours, right? Potential GDP is really only the sum of growth in trend hours and trend productivity.

So, the surge in immigration we saw really boosted potential growth up to 2.5 per cent to 3 per cent in recent years. So, if we reduce immigration, potential growth should slow. I think back towards, say, 2 per cent this year, maybe even 1 to 1.5 per cent next year. So, you slow down growth in the labor force, potential should moderate.

Second, and I think the more difficult question is, well, okay, if you also reduce growth in the labor force, you're going to get less employment, and that's a demand side effect. So, which dominates here, the supply side or the demand side? And here, I think to go back to your first question – yeah, I do think we're going to get a reversal of the outcome that we just saw.

So, I think it'll moderate both potential and actual growth. So, I think actual growth slows. The amount of employment we see should decline and soften. We're not saying the level of employment will decline, but the growth rate of employment should slow. But it should coincide with a low unemployment rate, so it's going to be a very different labor market. A lot less employment growth, but still a tight labor market in terms of low unemployment.

That should keep wages firm, particularly in the service sector where a lot of immigrants work, and we think it'll also help keep inflation firm. So, it could keep the Fed on the sideline for a significant period of time, for example.

And I'd just like to close, Mike, by saying I think this is an underappreciated risk for financial markets. I think investors have digested trade policy uncertainty, but I'm not convinced that risks around immigration and their effect on the economy are well understood.

Michael Zezas: Got it. Well Michael, thanks for taking the time to talk.

Michael Gapen: Thank you.

Michael Zezas: Thanks for listening. If you enjoy the show, leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

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