Europe in the Global AI Race

Our Chief U.S. Economist Michael Gapen discusses the possible economic implications of restrictive immigration policies in the U.S., highlighting their potential effect on growth, inflation and labor markets.----- Transcript -----Welcome to Thoughts on the Market. I’m Michael Gapen, Morgan Stanley’s Chief U.S. Economist. Today I’ll talk about the way restrictive immigration policies could potentially slow U.S. economic growth, push up inflation, and impact labor markets.It’s Wednesday, February 26th, at 2pm in New York.Lately, investors have been focused on the twists and turns of Trump’s tariffs. Several of my colleagues have discussed the issue of tariffs from various angles on this show. But we think the new administration’s immigration policy deserves more attention. Immigration is more than just the entry of foreign citizens into the U.S. for residency. It's a complex process with significant implications for our economy. According to the Bureau of Labor Statistics, as of June 2024, 19 per cent of the US workforce was made up of immigrants – which is over 32 million people. This is a significant increase from 1994, when only about 10 per cent of the workforce was foreign-born. Immigrants tend to be employed in sectors like agriculture, construction and manufacturing, but also in face-to-face services sectors like retail, restaurants, hotels and healthcare. Immigration surged to about 3 million per year after the pandemic. In fact, immigration rates in 2022 to 2024 were more than twice the historical run rate. This surge helped the US economy to "soft land" following a period of high inflation. It boosted both the supply side and the demand side of the U.S. economy. Labor force growth outpaced employment, which helped to moderate wage and price pressures. However, Trump’s policymakers are changing the rules rapidly and reversing the immigration narrative. Already by the second half of 2024, border flows were slowing significantly based on the lagged effects of steps previously taken by the Biden administration. Under the new administration, news reports suggest immigration has slowed to near zero in recent weeks.In our 2025 year-ahead outlook, we noted that restrictive immigration policies were a key factor in our prediction for slower growth and firmer inflation. We estimate that immigration will slow from 2.7 million last year to about 1 million this year and 500,000 next year. The recent data suggests immigration may slow every more forcefully than we expect.If immigration slows broadly in line as we predict, the result will be that population growth in 2025 will be about 4/10ths of 1 per cent. That’s less than half of what the U.S. economy saw in 2024. The impact of slower immigration on labor force measures should be visible over time. For the moment though, there is enough noise in monthly payrolls and the unemployment rate to mask some of the labor force effects. But over three or six months, the impact of slower immigration should become clearer.In terms of economic growth, if immigration falls back to 1 million this year and 500,000 next year, this could reduce the rate of GDP growth by about a-half a percentage point this year and maybe even more next year, and put upward pressure on inflation, particularly in services, and to some extent overall wages. Slower immigration could pull short-run potential GDP growth down from the 2.5-3.0 per cent that we saw in recent years to 2 per cent this year, and 1-1.5 per cent next year. On the other hand, the unemployment rate might fall modestly as immigration controls reduce the number of households with high participation rates and low spending capacity. This could lead to tighter labor markets, moderately faster wage growth, and upward pressure on inflation. So we think we are looking at a two-speed labor market. Slower employment growth will feel soft and sluggish. But a low unemployment rate suggests the labour market itself is still tight. Given all of this, we think more restrictive immigration policies could lead to tighter monetary policy and keep the Fed on its currently restrictive stance for longer. All of this supports our expectation of just one cut this year and further rate cuts only next year after growth slows.Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

26 Feb 4min

A shift to private destinations for cruise lines could affect both operators and guests by 2030. Our Europe Leisure & Travel analyst Jamie Rollo explains.----- Transcript -----Welcome to Thoughts on the Market. I’m Jamie Rollo, Morgan Stanley’s Europe Leisure & Travel Analyst. And today I’ll talk about an intriguing trend – the cruise lines’ accelerating expansion into private islands. It’s Tuesday, February the 25th, at 2 PM in London.Now the lure of a private island cruise is simple. You get almost exclusive access to a tropical retreat. You can lounge or snorkel on a pristine beach, you can enjoy a meal in a private cabana, you can even book a massage or a yoga class. The only other people around are fellow passengers on your vacation. So this isn't just the stuff of popular TV shows. It’s potentially the future of cruising. Cruise lines have actually been offering private islands for more than a decade. So it’s hardly a new phenomenon. In fact, in 2019, we estimate the majority of Caribbean cruise passengers visited a private island. As it happens, the Caribbean is the world's largest cruise destination. About saw 36 million cruise calls were there last year; that’s about 40 percent of global passenger capacity. And that’s surpassing the second largest region, the Mediterranean, at about 17 percent. Of course, the Caribbean’s proximity to North America and its year-round tropical climate make it a prime location for cruising. But despite these advantages, historically the Caribbean’s been seen as more of a lower-yielding market compared to regions like Europe or Alaska, which arguably have even more amazing scenery or historic sites. Interestingly, recent trends suggest that reputation might be changing. And new private islands over the last few years have reinvigorated the Caribbean cruise market. So what’s a private destinations or islands offer? For your guests, they get a seamless integration with the cruise experience. There’s no transfer required to a destination. There’s no external visitors coming into the resort. No-hassle, no-traffic, and very low crime. And for the cruise lines, well, they get greater control over the customer experience. They create superior customer satisfaction, which generates more repeat business. In addition, they can get that on-island spend that the guest would have spent with external vendors. And they can charge premium rates for exclusive areas. On top of that, many of these islands are quote close to the U.S. mainland, so you’re saving on fuel because the ship doesn’t have to steam so far; and on port fees. And then finally, proximity to the U.S. also can increase the short cruise duration market, which widens the addressable market for new-to-cruise passengers. And also can limit anti-tourism or anti-cruise sentiment because it moves guests out of congested areas and prevents unwanted visitors. All in all, the private island model offers a very high return on invested capital and may well be the future of the cruise line industry. In fact, if we add up the expansion plans of the biggest listed cruise lines, we think their private island guest count will double over the next few years. And that could add over 10 per cent to top line sales and 30 per cent earnings-per-share for the fastest growing cruise lines. So very considerable financials, but also it’s a private paradise within reach … and an idea we can all set sail to. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

25 Feb 4min

Our CIO and Chief U.S. Equity Strategist Mike Wilson explains the challenges to growth for U.S. stocks and why some investors are looking to China and Europe.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today on the podcast I’ll be discussing new headwinds for growth and what that means for equities. It's Monday, Feb 24th at 11:30am in New York. So let’s get after it. Until this past Friday’s sharp sell off in stocks, the correlation between bond yields and stocks had been in negative territory since December. This inverse correlation strengthened further into year-end as the 10-year U.S. Treasury yield definitively breached 4.5 per cent on the upside for the first time since April of 2024. In November, we had identified this as an important yield threshold for stock valuations. This view was based on prior rate sensitivity equities showed in April of 2024 and the fall of 2023 as the 10-year yield pushed above this same level. In our view, the equity market has been signaling that yields above this point have a higher likelihood of weighing on growth. Supporting our view, interest rate sensitive companies like homebuilders have underperformed materially. This is why we have consistently recommended the quality factor and industries that are less vulnerable to these headwinds.In our year ahead outlook, we suggested the first half of 2025 would be choppier for stocks than what we experienced last fall. We cited several reasons including the upside in yields and a stronger U.S. dollar. Since rates broke above 4.5 per cent in mid-December, the S&P 500 has made no progress. Specifically, the 6,100 resistance level that we identified in the fall has proven to be formidable for the time being. In addition to higher rates, softer growth prospects alongside a less dovish Fed are also holding back many stocks. As we have also discussed, falling rates won’t help if it’s accompanied by falling growth expectations as Friday’s sharp selloff in the face of lower rates illustrated. Beyond rates and a stronger US dollar, there are several other reasons why growth expectations are coming down. First, the immediate policy changes from the new administration, led by immigration enforcement and tariffs, are likely to weigh on growth while providing little relief on inflation in the short term. Second, the Dept of Govt Efficiency, or DOGE, is off to an aggressive start and this is another headwind to growth, initially.Third, there appears to have been a modest pull-forward of goods demand at the end of last year ahead of the tariffs, and that impulse may now be fading. Fourth, consumers are still feeling the affordability pinch of higher rates and elevated price levels which weighed on last month's retail sales data. Finally, difficult comparisons, broader awareness of Deep Seek, and the debate around AI [CapEx] deceleration are weighing on the earnings revisions of some of the largest companies in the major indices.All of these items are causing some investors to consider cheaper foreign stocks for the first time in quite a while – with China and Europe doing the best. In the case of China, it’s mostly related to the news around DeepSeek and perhaps stimulus for the consumer finally arriving this year. The European rally is predicated on hopes for peace in Ukraine and the German election results that may lead to the loosening of fiscal constraints. Of the two, China appears to have more legs to the story, in my opinion. Our Equity Strategy in the U.S. remains the same. We see limited upside at the index level in the first half of the year but plenty of opportunity at the stock, sector and factor levels. We continue to favor Financials, Software over Semiconductors, Media/Entertainment and Consumer Services over Goods. We also maintain an overriding penchant for quality across all size cohorts.Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

24 Feb 4min

Our Hong Kong/China Transportation & Infrastructure Analyst Qianlei Fan explores how a potential peace deal in Ukraine could reshape the global airline industry.----- Transcript -----Welcome to Thoughts on the Market. I’m Qianlei Fan, Morgan Stanley’s Hong Kong/China Transportation Analyst. Today’s topic is how a potential peace deal in Ukraine could affect global airlines. It’s Friday, February 21st, at 2pm in Hong Kong. The situation remains fluid, but we believe a potential peace deal in Ukraine could have broad implications for the global airline industry. From the reopening of Russian airspace to potential changes in fuel prices and flight routes, there are many variables at play. Russian airspace is currently off-limits due to the conflict, but a peace agreement could change that. The reopening of Russian airspace would be a significant catalyst for global airlines, reducing travel times and fuel consumption on routes between Europe, North America, and Asia. Fuel prices account for 20-40 per cent of airlines' costs, so any changes can have a significant impact on their bottom line. We believe a peace deal could lead to a moderate fall in fuel prices, benefiting all airlines, but particularly those with high-cost exposure and low margins. There could also be specific regional implications. The European air travel market could benefit significantly from an end to the Ukraine conflict. The reopening of Russian airspace would improve European airlines’ competitiveness on Asian routes, while a fall in fuel prices would reduce their operating costs. There would also be lower congestion in the intra-European market. Asian airlines, particularly Chinese ones, could experience a mixed impact. On the one hand, they could see an increase in wide-body utilization and passenger numbers if more direct flights to the U.S. are introduced. On the other hand, losing their advantage over European airlines of flying through Russian airspace would be negative. But, at the same time, Chinese airlines should remain competitive on pricing given meaningfully lower labor costs. U.S. airlines could also benefit in two significant ways. They could see a boost in revenues from adding back profitable routes such as U.S. to India or U.S. to South Korea that may have been suspended. Being able to fly directly over Russia would mean shorter, more direct flight paths resulting in less fuel burn and lower costs. U.S. airlines could also see a cost decrease from a moderate fall in jet fuel prices. Finally, Latin American carriers could also benefit from a peace deal. If global carriers reallocate capacity to China, it could tighten the market even further, creating an attractive capacity environment for the LatAm region. We’ll continue to bring you relevant updates on this evolving situation. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

21 Feb 3min

Our Global Chief Economist Seth Carpenter explains the potential domino effect that President Trump’s reciprocal tariffs could have on the U.S. and global economies.----- Transcript -----Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist, and today I'm going to talk about downside risks to the U.S. economy, especially from tariffs.It's Thursday, February 20th at 10am in New York.Once again, tariffs are dominating headlines. The prospect of reciprocal tariffs is yet one more risk to our baseline forecast for the year. We have consistently said that the inflationary risk of tariffs gets its due attention in markets but the adverse growth implications that's an underappreciated risk.But we, like many other forecasters, were surprised to the upside in 2023 and 2024. So maybe we should ask, are there some upside risks that we're missing?The obvious upside risk to growth is a gain in productivity, and frequent readers of Morgan Stanley Research will know that we are bullish on AI. Indeed, the level of productivity is higher now than it was pre-COVID, and there is some tentative estimate that could point to faster growth for productivity as well.Of course, a cyclically tight labor market probably contributes and there could be some measurement error. But gains from AI do appear to be happening faster than in prior tech cycles. So, we can't rule very much out. In our year ahead outlook, we penciled in about a-tenth percentage point of extra productivity growth this year from AI. And there is also a bit of a boost to GDP from AI CapEx spending.Other upside risks, though, they're less clear. We don't have any boost in our GDP forecast from deregulation. And that view, I will say, is contrary to a lot of views in the market. Deregulation will likely boost profits for some sectors but probably will do very little to boost overall growth. Put differently, it helps the bottom line far more than it helps the top line. A notable exception here is probably the energy sector, especially natural gas.Our baseline view on tariffs has been that tariffs on China will ramp up substantially over the year, while other tariffs will either not happen or be fleeting, being part of, say, broader negotiations. The news flow so far this year can't reject that baseline, but recently the discussion of broad reciprocal tariffs means that the risk is clearly rising.But even in our baseline, we think the growth effects are underestimated. Somewhere in the neighborhood of two-thirds of imports from China are capital goods or inputs into U.S. manufacturing. The tariffs imposed before on China led to a sharp deterioration in industrial production. That slump went through the second half of 2018 and into and all the way through 2019 as a drag on the broader economy. Just as important, there was not a subsequent resurgence in industrial output.Part of the undergraduate textbook argument for tariffs is to have more produced at home. That channel works in a two-economy model. But it doesn't work in the real world.Now, the prospect of reciprocal tariffs broadens this downside risk. Free trade has divided production functions around the world, but it's also driven large trade imbalances, and it is precisely these imbalances that are at the center of the new administration's focus on tariffs. China, Canada, Mexico – they do stand out because of their imbalances in terms of trade with the U.S., but the underlying driving force is quite varied. More importantly, those imbalances were built over decades, so undoing them quickly is going to be disruptive, at least in the short run.The prospect of reciprocity globally forces us as well to widen the lens. The risks aren't just for the U.S., but around the world. For Latin America and Asia in particular, key economies have higher tariff supply to U.S. goods than vice versa.So, we can't ignore the potential global effects of a reciprocal tariff.Ultimately, though, we are retaining our baseline view that only tariffs on China will prove to be durable and that the delayed implementation we've seen so far is consistent with that view. Nevertheless, the broad risks are clear.Thanks for listening. And if you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

20 Feb 4min

Our co-heads of Securitized Products Research, James Egan and Jay Bacow, explain how the increase in home prices, a tight market supply and steady mortgage rates are affecting home sales.----- Transcript -----James Egan: Welcome to Thoughts on the Market. I'm Jim Egan, co-head of Securitized Products Research at Morgan Stanley.Jay Bacow: And I'm Jay Bacow, the other co-head of Securitized Products Research at Morgan Stanley.Today, a look at the latest trends in the mortgage and housing market.It's Wednesday, February 19th, at 11am in New York.Now, Jim, there's been a lot of headlines to kick off the year. How is the housing market looking here? Mortgage rates are about 80 basis points higher than the local lows in September. That can't be helping affordability very much.James Egan: No, it is not helping affordability. But let's zoom out a little bit here when talking about affordability. The monthly payment on the medium-priced home had fallen about $225 from the fourth quarter of 2023 to local troughs in September. About a 10 percent decrease. Since that low, the payment has increased about $150; so, it's given back most of its gains.Importantly, affordability is a three-pronged equation. It's not just that payment. Home prices, mortgage rates, and incomes. And incomes are up about 5 percent over the past year. So, affordability has improved more than those numbers would suggest, but those improvements have certainly been muted as a result of this recent rate move. Jay Bacow: Alright. Affordability is up, then it’s down. It’s wrong, then it’s right. It sounds like a Katy Perry song. So, how have home sales evolved through this rollercoaster?James Egan: Well, you and I came on this podcast several times last year to talk about the fact that home sales volumes weren't really increasing despite the improvement in affordability. One point that we made over and over again was that it normally takes 9 to 12 months for sales volumes to increase when you get this kind of affordability improvement. And that would make the fourth quarter of 2024 the potential inflection point that we were looking for. And despite this move in mortgage rates, that does appear to have been the case. Existing home sales had a very strong finish to last year. And in the fourth quarter, they were up 8 percent versus the fourth quarter of 2023. That's the first year-over-year increase since the second quarter of 2021.Jay Bacow: All right. So that's pretty meaningful. And if looking backward, home sales seem to be inflecting, what does that mean for 2025?James Egan: So, there's a number of different considerations there. For one thing, supply – the number of homes that are actually for sale – is still very tight, but it is increasing. It may sound a little too simplistic, but there do need to be homes for sale for homes to sell, and listings have reacted faster than sales. That strong fourth quarter in existing home sales that I just mentioned, that brought total sales volumes for the year to 1 percent above their 2023 levels. For sale inventory finished the year up 14 percent.Jay Bacow: Alright, that makes sense. So, more people are willing to sell their home, which means there's a little bit more transaction volume. But is that good for home prices?James Egan: Not exactly. And it is those higher listings and our expectation that listings are going to continue to climb that's been the main factor behind our call for home price growth to continue to slow. Ultimately, we think that you see home sales up in the context of about 5 percent in 2025 versus 2024.Our leading indicators of demand have softened, a little, in December and January, which may be a result of this sharp increase in rates. But ultimately, when we look at turnover in the housing market, and we're talking about existing sales as a share of the outstanding homes in the U.S. housing market, we think that we're kind of at the basement right now. If we're wrong in our sales volume call, I would think it's more likely that there are more sales than we think. Not less.Jay Bacow: Let me ask you another easy question. How far would rates have to fall to really incentivize more supply and/or demand in the housing market?James Egan: That's the $45 trillion question. We think the current housing market presents a fascinating case study in behavioral economics. Even if mortgage rates were to decline to 4.5 percent, only 35 percent of people would be in the money. And that's still over 200 basis points from where we are today.That being said, we think it's unlikely that mortgage rates need to fall all the way to that level to unlock the housing market. While the lack of any historical precedent makes it difficult for us to identify a specific threshold at which activity could increase meaningfully, we recently turned to Morgan Stanley's AlphaWise to conduct a consumer pulse survey to get a better sense of how people were feeling about their housing options.Jay Bacow: I like data. How are those people feeling?James Egan: All right, so 31 percent of people anticipate buying a home over the next two years, and almost half are considering buying over the next five. Interestingly, only 21 percent are considering selling their home over the next two years. In other words, perceived demand is about 50 percent greater than marginal supply, at least in the immediate future, which we think could be a representation of that lock-in effect.Current homeowners’ expectations of near-term listings are depressed because of how low their mortgage rate is. But we did ask: What if mortgage rates were to fall from 6.8 percent today to 5. 5 percent? In that world, 85 to 90 percent of the people planning to buy a home in the next two years stated that they would be more likely to execute on that purchase.So, we think it's safe to say that a decline in mortgage rates could accelerate purchase decisions. But Jay, are we going to see that decline?Jay Bacow: Well, our interest rate strategists do think that rates are going to rally from here. They've updated their 10-year forecast to expect the tenure note ends 2025 at 4 percent. If the tenure note's at 4 percent, mortgage rate should come down from here, but not to that 4.5 percent, or probably even that 5.5 percent level that you quoted. You know, honestly, you don't really want to stay, you don't really want to go. We're probably talking about like a 6 percent mortgage rate. Not quite that level.But Jim, this is a national level, a national mortgage rate, and housing markets about location and location and location. Are there geographical nuances to your forecast?James Egan: People all over the country are asking, should they stay or should they go now, and that answer is different depending on where you live, right? If you look at the top 100 MSAs in the country, 8 of the top 11 markets showing the largest increases in inventory over the past year can be found in Florida.So, we would expect Florida to be a little bit softer than our national numbers. On the other hand, inventory growth has been most subdued in the Northeast and the Midwest, with several markets continuing to see inventory declines.Jay Bacow: All right, well selfishly, as somebody that lives in the Northeast, I am a little bit happy to hear that. But otherwise, Jim, it's always a pleasure listening to you.James Egan: Pleasure talking to you too, Jay. Thanks for listening, and if you enjoy this podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.DISCLAIMERJay Bacow: So, Jim, the lock-in effect is: You don’t really want to stay. No. But you don’t really want to go.James Egan: That is exactly; that is perfect! Wow. That is the whole issue with the housing market.

19 Feb 7min

Our CIO and Chief U.S. Equity Strategy Mike Wilson suggests that stock, factor and sector selection remain key to portfolio performance.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Today on the podcast I’ll be discussing equities in the context of higher rates and weaker earnings revisions. It's Tuesday, Feb 18th at 11:30am in New York. So let’s get after it.Since early December, the S&P 500 has made little headway. The almost unimpeded run from the summer was halted by a few things but none as important as the rise in 10-year Treasury yields, in my view. In December, we cited 4 to 4.5 percent as the sweet spot for equity multiples assuming growth and earnings remained on track. We viewed 4.5 percent as a key level for equity valuations. And sure enough, when the Fed leaned less dovish at its December meeting, yields crossed that 4.5 percent threshold; and correlations between stocks and yields settled firmly in negative territory, where they remain. In other words, yields are no longer supportive of higher valuations—a key driver of returns the past few years. Instead, earnings are now the primary driver of returns and that is likely to remain the case for the foreseeable future. While the Fed was already increasingly less dovish, the uncertainty on tariffs and last week’s inflation data could further that shift with the bond market moving to just one cut for the rest of the year. Our official call is in line with that view with our economists now just looking for just one cut–in June. It depends on how the inflation and growth data roll in. Our strategy has shifted, too. With the S&P 500 reaching our tactical target of 6100 in December and earnings revision breadth now rolling over for the index, we have been more focused on sectors and factors. In particular, we’ve favored areas of the market showing strong earnings revisions on an absolute or relative basis.Financials, Media and Entertainment, Software over Semiconductors and Consumer Services over Goods continue to fit that bill. Within Defensives, we have favored Utilities over Staples, REITs and Healthcare. While we’ve seen outperformance in all these trades, we are sticking with them, for now. We maintain an overriding preference for Large-cap quality unless 10-year Treasury yields fall sustainably below 4.5 percent without a meaningful degradation in growth. The key component of 10-year yields to watch for equity valuations remains the term premium – which has come down, but is still elevated compared to the past few years. Other macro developments driving stock prices include the very active policy announcements from the White House including tariffs, immigration enforcement, and cost cutting efforts by the Department of Government Efficiency, also known as DOGE. For tariffs, we believe they will be more of an idiosyncratic event for equity markets. However, if tariffs were to be imposed and maintained on China, Mexico and Canada through 2026, the impact to earnings-per-share would be roughly 5-7 percent for the S&P 500. That’s not an insignificant reduction and likely one of the reasons why guidance this past quarter was more muted than fourth quarter results. Industries facing greater headwinds from China tariffs include consumer discretionary goods and electronics. Lower immigration flow and stock is more likely to affect aggregate demand than to be a wage cost headwind, at least for public companies. Finally, skepticism remains high as it relates to DOGE’s ability to cut Federal spending meaningfully. I remain more optimistic on that front, but realize greater success also presents a headwind to growth before it provides a tailwind via lower fiscal deficits and less crowding out of the private economy—things that could lead to more Fed cuts and lower long-term interest rates as term premium falls. Bottom line, higher backend rates and growth headwinds from the stronger dollar and the initial policy changes suggest equity multiples are capped for now. That means stock, factor and sector selection remains key to performance rather than simply adding beta to one’s portfolio. On that score, we continue to favor earnings revision breadth, quality, and size factors alongside financials, software, media/entertainment and consumer services at the industry level. Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

18 Feb 4min

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.----- Transcript -----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.

14 Feb 9min