Trump 2.0 and the Potential Economic Impact of Immigration Policy

Summary

Thoughts on the Market: Trump 2.0 and the Potential Economic Impact of Immigration Policy

Hosted by Morgan Stanley | Release Date: February 14, 2025

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Introduction to the Discussion

In the February 14, 2025 episode of Thoughts on the Market, hosted by Morgan Stanley, experts Michael Zesas and Michael Gapen delve into the implications of a potential second term for President Trump, focusing specifically on immigration policy and its broader economic ramifications. The conversation navigates through recent immigration trends, proposed policy changes, and the anticipated effects on the U.S. economy.

Pre-Trump Immigration Trends and Economic Impact

Michael Gapen begins by setting the stage with historical immigration data, highlighting the surge in immigration post-pandemic.

Michael Gapen [01:14]: "In 2022 through 2024, we saw immigration surge to about 3 million per year. So about twice as fast as we saw normally."

This significant increase, double the 20-year average of 1.5 million immigrants annually, played a crucial role in the U.S. economy's recovery from the pandemic. The influx bolstered the labor force precisely when demand for labor was high, facilitating rapid economic growth while helping to keep wages stable and inflation in check. Gapen asserts that this immigration-driven growth was a key factor in the U.S. achieving a "soft landing"—a scenario where the economy slows without triggering a recession.

Trump's Proposed Immigration Policies

As the conversation shifts to the potential implications of a second Trump presidency, the focus turns to proposed immigration policies aimed at reversing the recent trends.

Michael Gapen [02:26]: "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."

Gapen emphasizes that the Trump administration is likely to prioritize border strengthening and increased deportations as part of its immigration strategy. He references initiatives initiated by the preceding Biden administration, such as policies that began to slow immigration flows mid-last year, suggesting that Trump’s policies would build upon these measures.

Michael Zesas elaborates on the specific mechanisms through which the Trump administration might implement these changes:

Michael Zesas [03:25]: "There's stepped up deportations and removals and there's working with Mexico on border enforcement... such as the remain in Mexico policy."

The "Remain in Mexico" policy, which mandates asylum seekers to stay in Mexico while their cases are processed, represents a significant shift in border enforcement strategy. Additionally, the administration is considering imposing tariffs on Mexico and Canada contingent upon improvements in border security.

Potential Economic Ramifications

The discussion then pivots to the potential economic consequences of reduced immigration. Gapen outlines a multi-faceted impact:

Michael Gapen [07:29]: "Reduced immigration should lead to slower potential growth... potential growth should slow back towards say, 2% this year, maybe even 1 to 1.5% next year."

A decline in immigration would likely result in slower growth of the labor force, which in turn would dampen overall economic growth. Gapen explains that potential GDP growth, which currently benefits from a robust labor supply, could decrease to between 1% and 2%, down from the recent 2.5% to 3%. This slowdown would also affect employment growth rates, although the labor market would remain tight with low unemployment rates. Consequently, wages, especially in the service sectors heavily reliant on immigrant labor, may remain firm, thereby sustaining inflationary pressures.

Furthermore, Gapen suggests that persistent inflation could influence Federal Reserve policies, potentially keeping interest rates higher for a longer period to manage inflation without overheating the economy.

Uncertainties and Challenges in Assessing Impact

Both analysts acknowledge the inherent uncertainties in predicting the exact outcomes of the proposed immigration policies. Zesas points out the difficulty investors face in real-time assessment due to delayed data on immigration flows and labor market changes.

Michael Zesas [04:18]: "It will be difficult for investors... Mostly it's a data challenge here."

He notes that while official government statistics provide some insights, the lag in data reporting hinders timely analysis. Additionally, anecdotal evidence from industries like construction and hospitality may offer hints but lacks the robustness needed for definitive conclusions.

Gapen reinforces this uncertainty by suggesting a range of possible immigration flow scenarios, from a benign reduction to more severe declines, depending on the effectiveness of the administration's policies and external factors such as international relations with neighboring countries.

Long-term Economic Outlook

Looking ahead, Gapen presents a cautiously pessimistic outlook on future immigration trends and economic growth:

Michael Gapen [05:38]: "Our outlook is that immigration flows should slow below pre-Covid averages to about 1 million this year and about 500,000 in 2026."

Such a significant reduction, far below the longstanding average, would mark a stark departure from recent immigration patterns and signal a major shift in the U.S. labor market dynamics. This slowdown would not only temper potential growth but also influence consumer demand, business investments, and overall economic vitality.

Gapen underscores that the combination of reduced labor force growth and sustained low unemployment would create a "very different labor market," characterized by slower employment growth and firm wages, potentially leading to enduring inflationary trends.

Closing Insights

In concluding the discussion, Gapen highlights an often-overlooked risk for financial markets:

Michael Gapen [09:27]: "I think this is an underappreciated risk for financial markets... risks around immigration and their effect on the economy are not well understood."

He calls on investors to pay closer attention to immigration-related policies and their broader economic implications, suggesting that the potential slowdown in immigration could have far-reaching effects on market dynamics, investment strategies, and economic forecasts.

Conclusion

The episode of Thoughts on the Market offers a comprehensive examination of how a second Trump term could reshape U.S. immigration policy and, by extension, impact the economy. Michael Zesas and Michael Gapen provide insightful analyses on the potential slowdown in immigration flows, the mechanisms of proposed policy changes, and the resultant economic challenges. As the U.S. navigates these possible shifts, the episode underscores the importance of understanding immigration as a key driver of economic growth and stability.

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For more insights and detailed analyses, listen to the full episode or access the survey linked in the show notes to share your thoughts.

Transcript

[Andrew Sheats]

Hi, I'm Andrew Sheats, Head of Corporate Credit Research at Morgan Stanley. Before we get into today's episode, the team behind Thoughts on the Market wants your thoughts and your input. Fill out our listener survey and help us make this podcast even more valuable for you. The link is in the show notes and you'll hear it at the end of the episode. Plus, help us help the Feeding America organization. For every survey completed, Morgan Stanley will donate $25 towards their important work. Thanks for your time and the support onto the show.

[Michael Zesas]

Welcome to Thoughts on the Market. I'm Michael Zesas, Morgan Stanley's global head of fixed income and public policy research.

[Michael Gapen]

And I'm Michael Gapen, Chief US Economist for Morgan Stanley.

[Michael Zesas]

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 US 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 US Economy to soft land after several years of above target inflation.

[Michael Zesas]

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 Zesas]

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 US Is pushing on to try and reduce the flow of migrants coming into the US 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. Those have been delayed. Is there anything on the horizon we should look for this time around?

[Michael Zesas]

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 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 from 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 of months on exactly what's happening. But based on all this, Michael, what's your outlook for immigration this year and beyond?

[Michael Gapen]

So, 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 well below the long run average of about 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 1.5 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 Zesas]

Got it. So lots of crosscurrents here about how the actual labor 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 US Economy?

[Michael Gapen]

Yes, a lot of crosscurrents 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. 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 to 3% in recent years. So if we reduce immigration, potential growth should slow, I think, back towards say, 2% this year, maybe even 1 to 1.5% 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 Zesas]

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

[Michael Gapen]

Thank you and thanks for listening.

[Michael Zesas]

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