Macro Signposts | 25 June 2024

I would like to thank Graeme Westwood, economist, for his insights and contributions to this edition.

Unless explicitly stated, views expressed do not constitute official PIMCO views.

Could Declining Immigration Ease U.S. Shelter Inflation?

Since 2022, we've argued that the last mile of the U.S. inflation journey back to 2% (the Federal Reserve's target) was going to be the slowest. That view has largely played out, with surprisingly sticky inflation even delaying Fed rate cuts this year.

However, a return toward disinflation may be more imminent now. A slowdown in immigration could ease some of the inflationary pressure in housing markets, especially in the largest cities - and could help narrow, or even close, the gap between the current inflation rate and the 2% target.

Quick background: U.S. headline consumer price index (CPI) inflation peaked in June 2022 at an annualized pace of 9.1%. We argued in the 15 November 2022 Macro Signposts that getting from 8% inflation down to 4% was going to be relatively easy as the inflationary spike from energy and pandemic-impacted core goods categories faded. However, getting from 4% all the way back to 2% was going to be slower and more nuanced, likely needing more labor market cooling.

Since then, labor markets have cooled (largely through declines in job openings), and the unemployment rate has risen 0.6 percentage points from its 3.4% low, according to the U.S. Bureau of Labor Statistics (BLS).

However, headline inflation has been trending sideways at around 3.5% for the better part of a year.

Persistent inflationary pressure in U.S. housing markets
Analysis suggests still-elevated shelter inflation has been a key contributor to the lack of overall progress on U.S. inflation. Excluding shelter from the CPI basket, headline inflation has been running around 2%, give or take, for about a year now - see Figure 1.

Figure 1: Headline U.S. CPI inflation ex shelter has been around 2% annualized since May 2023

Chart01

Source: U.S. Bureau of Labor Statistics as of May 2024

What's driving the slow progress on shelter inflation? In our 21 February 2024 Macro Signposts, we cited three factors: First, a still-wide gap between the average level of all rents (which is captured by the CPI) and market rents (captured by private industry data including Zillow and CoreLogic) would likely make owners' equivalent rent (OER) inflation slower to moderate as landlords were continuing to raise the rents of leases coming due in order to "catch up" to market rents. Second, rents of single-family detached structures - the majority of the OER sample - have remained much firmer than multifamily apartment units. Third, with owning a home now much less affordable, newly formed households will tend to rent, not buy - supporting higher prices in rental markets.

Interestingly, these arguments for slower progress toward lower shelter inflation don't fully account for what we've actually seen in rents and OER inflation. Shelter inflation has been essentially flat for the last six months (not slowly moderating), and in some of the largest cities, it has actually accelerated - see Figure 2.

Figure 2: U.S. owners' equivalent rent (OER) lingering above target

Chart02

Source: U.S. Bureau of Labor Statistics as of May 2024

Influx of immigrants helps explain shelter inflation data
Surging immigration over the last several years, along with a generally healthy economy, could explain much of the persistence in rents and OER inflation in the U.S.

We estimate immigration has been 2-3 million individuals per year above average for the last few years, driven by an influx of asylum seekers at the U.S. southern border. After entering the country, these individuals and families may wait three to almost six years in some cases for immigration court hearings, In the meantime, many migrate to large cities in hopes of finding work as they become eligible for employment authorization documents (EADs). We can approximate where within the country these immigrants eventually reside using data from Syracuse University's transactional records access clearinghouse on city- and state-level pending immigration court cases.

Historical studies have found higher immigration tended to boost shelter prices (especially in the more affordable segments) in the regions and cities where immigrants established new households. A 2006 study1 by Albert Saiz, a visiting scholar at the Philadelphia Fed and current faculty director of the Urban Economics Lab at MIT, estimated that for every 1 percentage point of the population increase due to international immigration into a city, rents increased by a similar 1 percentage point.

Extending his analysis to today and using pending asylum court cases to estimate the recent influx of immigrants into cities and local areas, it appears that immigration may have had a meaningful impact on rental inflation so far in 2024. We estimate it could have contributed around 2.2-2.5 percentage points to various large city rents and OER inflation, which accounts for an estimated one-third of the national basket, according to the BLS. In other words, if not for immigration, reported rents and OER inflation in large cities may be running closer to its 3.5% pre-pandemic year-over-year average versus its 5.7% reported pace today.

Inflation progress could get easier
The immigration data suggest how slow progress on shelter inflation in 2023 and 2024 may start to reverse in the months and quarters ahead: Since the turn of the year, reported U.S. southern border immigrant encounters have declined, while the Biden Administration has taken further steps to reduce these flows. (Learn more in our 11 June 2024 Macro Signposts.)

How soon could more rapid OER disinflation materialize? The Saiz analysis (and our extension of it) isn't very precise because its estimates are based on historical population data, which are only reported annually. That said, historically, reported rents and OER trend to lag other real-time fundamental economic trends by around two to three quarters (rental lease contracts tend to reset annually, causing a lag), implying sequential rents and OER inflation could start to step down now. We may have seen some evidence of that in the latest CPI inflation report: If not for a noisy-looking jump in New York City OER, which contributed an estimated 9 basis points to the monthly pace of nationwide OER inflation, monthly OER inflation would have stepped down in May to 0.34%.

Confidence boost
To be sure, it's a widely held view (including at PIMCO) that OER inflation will likely moderate in the second half of 2024. However, seeing the trend confirmed in the reported data (after the surprising lack of progress thus far this year) should make everyone, including Fed policymakers, more confident that U.S. inflation is moderating back toward 2%.

In our 11 April 2024 Macro Signposts, we argued that the first-quarter inflation acceleration - which was broader than just rents - would delay the Fed's first cut from June (which the central bank had previously signaled) back to potentially December. Indeed, when June arrived, Fed officials published a new median projection implying only one rate cut in 2024. However, with a big minority contingent of the committee still forecasting two cuts this year, a step down in OER inflation starting in June, and continuing in July and beyond, could be just what the Fed needs to see to consider an initial rate cut in September.

The unwinding of significant shocks to commodity markets and supply chains helped drive the initial decline in inflation. After that, policymakers and markets seemed to be caught off-guard by the inflationary impact from a population shock. As immigration slows and this additional shock unwinds, it is likely to help the Fed cross the last mile of inflation, while weighing on the growth outlook (see our 11 June 2024 Macro Signposts).

Regardless of the timing of the first cut, after observing immigration's impact on inflation over time, along with more balanced risks to growth, we've become more confident that Fed rate cuts haven't been canceled, just delayed.

1 Saiz, Albert. "Immigration and Housing Rents in American Cities," Discussion Paper No. 2189, Institute for the Study of Labor (Bonn, Germany), June 2006

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