Is immigration helping to slow wage growth?

Bottom Line 

Embedded in the Labor Department’s monthly jobs report, the growth in average hourly earnings has declined from a cycle peak of 5.9% year-over-year (y/y) in March 2022 to 3.9% in April 2024. The Federal Reserve believes that, if there is reasonable improvement in productivity, 3% might be the sustainable number to achieve its 2% inflation target. While this decline in wage growth is certainly encouraging for the Fed, it is inconsistent with stickiness of other inflation metrics, such as the cost of electricity, gasoline, food and housing. One reason for the difference might be the surge in illegal immigration across the southern U.S. border over the past three years.

Southern border dilemma According to the U.S. Border Patrol, nearly 8 million people have streamed across the southern border into Texas, New Mexico, Arizona, and California over the past three years through March 2024. That places budgetary pressure on the cities and counties in which they settle. The cost of housing, transporting, educating, and providing health care for them is largely shouldered by local, state and federal taxpayers.

Some undocumented immigrants have found employment, either on the books or as part of the under-the-table economy. According to the Labor Department’s household data report, the number of foreign-born workers (16 years of age and older) has increased over the 12 months to April by 520,000, establishing a worker participation rate of 66.0%.

But over this same period, the number of native-born workers (16 years of age and older) has declined by 5,000 through April 2024, with a participation rate of 61.7%. The overall participation rate in the U.S. economy was 62.7% in April. We believe this worker mix shift is contributing to the overall decline in average hourly earnings.

K-shaped recovery widens While this is difficult to quantify, subcategories of the unemployment rate present some evidence. The unemployment rate for highly educated workers has not changed substantially since its cycle low of 1.8% in September 2022. It reached only 2.2% last month. But the rate for less-educated workers has jumped, reaching 6.0% last month, up from its 31-year low of 4.4% in November 2022. This is inconsistent with the steady wage growth we are seeing, not to mention the historically low jobless rate. To the extent to which immigrants are working off the books, they maybe be competing with those less educated native-born workers.

Contradictory In contrast to the declining pace of earnings growth in April’s jobs report, the Employment Cost Index leapt 1.2% quarter-over-quarter (q/q) in the first quarter, up from a gain of 0.9% in the fourth quarter and the highest in a year. It annualizes to a gain of 4.2%. Unit labor costs in the first quarter surged 4.7% q/q annualized, the most in a year and up sharply from 0.0% in the fourth quarter. At the same time, nonfarm productivity plunged in the first quarter to 0.3% q/q annualized, down significantly from gains of 3.5% and 4.6% in the fourth and third quarters, respectively. 

Higher for much longer The overly optimistic consensus view on Wall Street at the beginning of this year was that the Fed would cut interest rates seven times during 2024, starting in March. Contrast that with last week’s FOMC meeting, in which Chair Jerome Powell reiterated it’s likely to take longer for the Fed to gain confidence the economy is on a sustainable path to its 2%. While it’s unlikely that the Fed’s next policy move would be to hike interest rates again, he said a patient and data-dependent approach is appropriate. We at Federated Hermes expect one or two rate cuts this year, and only after the election on November 5. 

Core PCE sticky The Fed’s preferred measure of inflation peaked at 5.6% y/y in February 2022 and has declined to 2.8% y/y in both February and March 2024. But it rose 0.3% m/m in both February and March, which annualizes to 3.6%. The Fed’s Summary of Economic Projections (SEP) in March forecasts core PCE to decline to 2.6% by year-end and reach 2% in 2026. 

Nominal CPI rising Inflation soared from 1.4% y/y in January 2021 to a 41-year peak of 9.1% in 2022. As the Fed began to raise interest rates and shrink its balance sheet, it plunged to 3.1% in January . But over the past two months, this metric has increased, touching 3.5% in March, as the base effects have rolled off, replaced by upward pressure from shelter, energy and food costs.

Need more data The Fed doesn’t move on single data points, but will certainly be poring over the upcoming inflation, retail sales and jobs reports to gauge its next policy move. This information could also shed more light on the role that illegal immigration is having on the economy.

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