Bi-Weekly Geopolitical Report – The Great COVID Labor Reform (May 20, 2024)

by Patrick Fearon-Hernandez, CFA | PDF

The COVID-19 pandemic of 2020 is now starting to fade from memory. Four years after the sudden outbreak of the disease sparked mass economic shutdowns, mask wearing, and millions of deaths, it’s tempting to think the crisis is becoming just another episode of history. However, the pandemic clearly led to changes in the global economy. For example, it helped usher in an era in which governments and companies worry a lot about potential supply chain disruptions.[1]

In this report, we discuss how the pandemic changed the United States labor supply. We focus on two key developments during the pandemic: 1) the mass excess retirements and deaths of baby boomers,[2] and 2) the generous income support programs implemented by the federal government. Considering these developments as a package, we show how they essentially amount to a labor market reform — perhaps the most significant US labor market reform in decades. We then examine how these labor market changes could help spur outsized US economic growth in the coming years, albeit with additional upward pressure on consumer price inflation and interest rates. We wrap up by examining the implications for investors.

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[1] This would not be the first time a pandemic affected the labor markets. The “Black Death” in the 1300s killed so many workers that the lucky survivors saw a jump in real wages. After the Spanish Flu epidemic of 1918, something similar occurred.

[2] The baby boomer generation is conventionally considered to be all those born from 1946 to 1964.

There will be no accompanying podcast for this report.

Asset Allocation Bi-Weekly – The Immigration Paradox (May 13, 2024)

by the Asset Allocation Committee | PDF

Throughout history, immigration has been a politically charged issue, creating a rift between capital and labor. Employers have advocated for looser immigration policies to fill job vacancies, particularly for positions that don’t offer high pay. Conversely, labor unions often push for stricter policies to prevent an influx of workers that could suppress wages. This long-standing divide presents a complex challenge for policymakers seeking a middle ground that satisfies both sides.

The recent surge in immigration has reignited tensions between populists and technocrats. While populists often worry about immigration’s impact on national security, technocrats highlight its potential economic benefits. Research by the nonpartisan Congressional Budget Office estimates that immigrants could contribute $7 trillion to the economy over the next decade. At the same time, there is hope that immigration could help the Federal Reserve achieve its dual mandate of price stability and full employment. According to Fed Chair Powell, the influx of new workers has allowed the country to add new jobs without triggering significant wage pressures.

The argument for allowing increased immigration has gained momentum due to the country’s ongoing shortage of relatively low-skilled workers. Household employment data reveals there has been a decline of 1.1 million workers without a college degree since March 2020. Demographics are also unfavorable. The US fertility rate has hit a record low of 1.62, significantly below the replacement rate of 2.1 children per woman. Falling birth rates have held back the supply of US-born workers. As a result, foreign workers may have accounted for most of the job growth going back to February 2020.

Nevertheless, there is a growing push for stricter immigration policies, even as additional workers are needed for the economy. A Harris Poll survey indicates that more than half of Americans favor tighter controls on illegal immigration. Interestingly, 42% of Democrats — a demographic typically associated with looser immigration restrictions — endorse such measures. This shift in public opinion briefly spurred bipartisan support for the most restrictive immigration bill in recent history. However, the legislation ultimately crumbled as politicians pushed for even stricter measures.

Despite public opposition, rising immigration has demonstrably helped the Fed limit price inflation while keeping employment high. Over the past four years, the influx of foreign workers has helped firms keep a lid on wage rates, thereby reducing cost-push inflation. The hiring of non-natives has also expanded the labor supply without boosting the unemployment rate. For example, the recent surge of foreign workers into the labor force coincided with a fall in the non-seasonally adjusted unemployment rate, from 4.2% in February to 3.9% in March.

Going forward, the rising pushback against immigration may complicate the Fed’s efforts to do its job. Since one of the Fed’s preferred inflation gauges, the Core PCE index for services, is closely linked to wages, a decrease in wage growth is likely necessary in order for the Fed to achieve its inflation target in a reasonable time frame. However, strict measures to limit foreign workers could support wage growth and constrain the Fed’s ability to cut interest rates. A tighter labor market due to fewer foreign workers could put upward pressure on wages, making it harder to control inflation.

Although immigration has helped temper inflation recently, political resistance makes it an unreliable long-term solution for the Fed. Absent significant productivity gains, a more limited labor force could exacerbate inflationary pressures, which could then necessitate restrictive monetary policy to keep price pressures contained. This could lead to a period of underperformance for long-term Treasurys as investors seek higher returns to offset inflation. Of course, the labor market has historically adjusted slowly to immigration changes, so the disinflationary effects of today’s immigration will probably continue for the foreseeable future. Nevertheless, a crackdown on immigration would likely contribute to a less positive environment for bonds in the longer term.

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Daily Comment (December 8, 2017)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] It’s employment data day!  We detail the data below but the short answer is that the numbers are good for capital—employment rose faster than forecast while wage growth came in weaker than expected.  The lack of wage growth should bring some degree of pause on the part of the FOMC.  Here are other items we are watching this morning:

Brexit goes forward: Britain and the EU reached a deal on exit terms, giving special rights to the four million EU expats in the U.K. and an exit fee of €40 bn to €60 bn.  The sticky problem of the border in Ireland was resolved; although the DUP did go along, in reality, it appears that Northern Ireland will, in terms of regulation, be a de facto member of the EU.  The U.K. did get some relief over EU jurisdiction.  Overall, it looks like PM May got a deal because she acquiesced at every level with the EU.  From here, negotiations will move on to trade.  Although this is a significant development, it appears the markets fully anticipated this outcome as the GBP is essentially flat.

Basel bank accords: Although the deal took almost two years longer than planned, the Basel III accords have been approved.  These rules apply to bank capital in 27 nations plus the entire EU.  The goal is to create uniform bank capital rules across the developed world to prevent financial contagion.  The disagreement was mostly U.S. versus EU; the former wanted stricter regulations because America’s financial structure makes businesses less dependent on banks and more on capital markets.  If the EU were forced to follow U.S. rules, the EU financial markets would need massive restructuring.  EU bank equities are up 3% on the news.

Continuing resolution: It looks like a short-term deal was struck to keep the government functioning but it will only last until around Christmas.  The sticking points are familiar—Democrats want an immigration break for dreamers and social spending equal to defense spending.  The GOP wants no immigration deal and only spending on defense.  This impasse looks difficult to resolve but the most likely outcome is higher spending and deficits.

A questionable invitation: Greece and Turkey are historical enemies.  For the first time in 65 years, the Turkish president visited Greece.  It may be an equal period of time before such an event happens again.  Turkish President Erdogan opened discussions by calling for a reworking of the 1923 Treaty of Lausanne, the treaty that established the border between the two nations.  Greece has no interest in adjusting the deal.  Erdogan also accused his hosts of discriminating against Muslim Turks who live in Greece.  Criticism of the aforementioned treaty and support of the Muslim Turkish minority are a page out of the authoritarians’ playbook; see Hitler’s absorption of the Sudetenland in 1939.  Erdogan also indicated that the division in Cyprus is due to Greek intransigence.  Needless to say, hopes for some sort of improvement in relations looks like a long shot.

German coalition negotiations: Martin Schulz, the leader of the SDP in Germany, is in talks with the CDU/CSU to create a new grand coalition in Germany.  If these talks fail, Germany will likely need new elections, which would be unprecedented in the postwar experience.  Schulz gave a rousing speech that called for a “United States of Europe” by 2025;[1] this would signal a dramatic reversal in the CDU/CSU’s platform, which is cautious over further European integration.  German conservatives are worried that further integration would entail Eurobonds (an EU bond backed by the full faith and credit of all EU members, meaning Germans would guarantee the debt of the other 26 members’ spending) and a unified fiscal budget.  Schulz is laying down his markers for forming a government with Merkel.  If he holds to this position, it seems highly unlikely that Merkel can form a government.

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