Immigration and the Labor Market

Bobby Zheng, CFA Investment Strategy Analyst Peter Donisanu Investment Strategy Analyst WEEKLY GUIDANCE ON ECONOMIC AND GEOPOLITICAL EVENTS Immigration and the Labor Market January 23, 2018 Key takeaways» The long-standing debate on U.S. immigration policies recently has resurfaced on Capitol Hill.» Empirical evidence suggests that a weak near-term relationship exists between changes in immigration and labor market conditions, yet long-term immigration remains an important part of the U.S. economy. What it may mean for investors» We still favor the Consumer Discretionary, Financials, Industrials, and Health Care sectors, even as immigration-policy changes could have a nuanced impact on the labor markets. At a high level, investors in the U.S. are concerned with factors that may impact inflation and the labor market. At a more granular level, recent events have reignited the long-standing debate on U.S. immigration policy and its near-term effect on wages and the labor market. While we believe that foreign-born workers are a critical longterm component of the U.S. labor force, our research suggests that a limited near-term relationship exists between changes in immigration levels and labor-market dynamics (wages and employment). Additionally, the potential for tighter immigration policies could create nuanced headwinds in certain labor-intensive industries. Immigrants compose a large part of the U.S. labor force According to the U.S. Census Bureau, the immigrant population in the U.S. reached a record 43.7 million, or 13.5% of the population, in 2016. In the same year, 27 million foreign-born persons were employed in the U.S. labor force, comprising 16.9% of the total. 1 In contrast, Japan, a country with more restrictive immigration policies, has 2.3 million immigrants that represent roughly 2% of the country s population comprising less than 1% of its labor force. Japan has been dealing with labor-force growth stagnation and an aging population for decades, partly due to its restrictive immigration policy. While Japan is reevaluating its immigration policies in an effort to overcome its labor-supply deficit, U.S. immigration policy still fosters a wide variety of working permits that support growth 1 According the U.S. Census Bureau, foreign-born individuals are persons who reside in the United States, but who were born outside the country or one of its outlying areas to parents who were not U.S. citizens. Foreign-born individuals include legally-admitted immigrants, refugees, temporary residents, such as students and temporary workers, and undocumented immigrants. 2018 Wells Fargo Investment Institute. All rights reserved. Page 1 of 6

in the labor force. While immigrant workers true effect on an economy is likely to remain a complex discussion, the case that immigrants are a critical part of the U.S. labor force is anecdotally evidenced in the number of foreign-born workers participating in the labor market. Chart 1. Japan versus. U.S. labor force growth divergence 170 90 150 80 U.S. total labor force in millions 130 110 90 70 60 Japan total labor force in millions 70 U.S. total labor force (LHS) Japan total labor force (RHS) 50 50 53' 57' 61' 65' 69' 73' 77' 81' 85' 89' 93' 97' 01' 05' 09' 13' 17' Sources: Wells Fargo Investment Institute, Japan Ministry of Internal Affairs and Communications, U.S. Bureau of Labor Statistics, December 31, 2017. Broad relationship between immigrant workers and unemployment rates or wages is limited With so many foreign-born workers already residing in the U.S., many academic studies have sought to determine whether a further influx of immigrant workers stemming from more lenient immigration policies would introduce disruptions in the existing labor market and cause wage levels to stagnate. Some of these studies findings suggest that, historically, there have been few near-term impacts on wages or the labor market from an immigration influx. We approach this issue similarly, by assessing whether broad, meaningful relationships exist between changes in the U.S. immigrant-worker population and the unemployment rate or wages. As demonstrated in the left panel of Chart 2, our analysis has established a weak-to-non-existent linear relationship 2 between the change in immigrant worker population (represented by the change in foreign-born workers) and the change in the U.S. unemployment rate. Similarly, changes in wages, measured in average hourly earnings, also have shown an unconvincing relationship with the change in immigrantworker levels (Chart 2, right panel). Consistent with other research findings, our work suggests that a convincing argument for a one-to-one, linear relationship between immigration and labor-market outcomes has yet to be made. 34 40 2 R-squared (R 2 ) is measure that attempts to explain the variation between dependent and independent factors. The higher the r-squared value, the higher the likelihood is that movements in the independent variable explain movements in the dependent variable. 3 "Mixing the Melting Pot: The Impact of Immigration on Labor Markets" Federal Reserve Bank of St. Louis, March 31, 2017. 4 Immigration and the American Worker A Review of the Academic Literature Center for Immigration Studies, April 9, 2013. 2018 Wells Fargo Investment Institute. All rights reserved. Page 2 of 6

Chart 2. Year-over-year (YoY) change in U.S. foreign-born employed persons versus YoY change in U.S. unemployment rate and average hourly earnings U-3 U.S. unemployment rate total in labor force (%) 11% 10% 9% 8% 7% 6% 5% 4% R 2 = 0.115 3% (8.0%) (6.0%) (4.0%) (2.0%) 0.0% 2.0% 4.0% 6.0% U.S. employment persons employed foreign born 16 years and over total (YoY) Sources: Wells Fargo Investment Institute, Bloomberg, U.S. Bureau Labor of Statistics, U.S. Data range is from January 31, 2007 to December 31, 2017. Immigration policies nuanced effects U.S. average hourly earnings all employees total private yearly percent change 1.0% (8.0%) (6.0%) (4.0%) (2.0%) 0.0% 2.0% 4.0% 6.0% We have established that weak relationships exist between broad immigration trends and labor-market conditions. On a more nuanced, case-by-case basis, the outcome of the immigration debate on Capitol Hill could have a limited impact on some laborintensive service sectors, because of the percent of foreign-born workers employed in those sectors. For example, several existing immigration programs that were established by past administrations are currently up for debate. These include the Diversity Visa program open to individuals from all backgrounds, and the H1-B and Trade National (TN) visa programs, which typically target professionals with highly developed technical skills. According to the Bureau of Labor Statistics, the proportion of foreign-born workers who work in agriculture, construction, and other service occupations is noticeably higher than that of native-born workers (Chart 3). Restrictive immigration policies could create meaningful headwinds for corporations in industries such as construction, manufacturing, and transportation that rely heavily on a healthy supply of workers. Chart 3. Employed foreign-born and native-born persons 16 years and older (by occupation) Native born 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% R 2 = 0.313 U.S. employment persons employed foreign born 16 years and over total (YoY) Foreign born Management and professional Service occupations Sales and office Natural resources/agriculture, construction, and maintenance Production, transportation, and material moving Sources: Wells Fargo Investment Institute, Bureau of Labor Statistics, as of December 31, 2017. 2018 Wells Fargo Investment Institute. All rights reserved. Page 3 of 6

Investment implications The debate on immigration policies in the U.S. has been ongoing, and it is likely to continue for quite some time. At a broad level, we expect the potential for more restrictive immigration policies to have a limited near-term impact on the U.S. economic expansion. Yet, a compelling argument could be made that restrictive immigration policies may create headwinds for the U.S. economy over a longer period of time as birth rates fall and the population ages (similar to the trend in Japan, as we discussed earlier). In the near term, however, we believe that the negative effects of restrictive immigration policy headwinds likely could be offset by tailwinds from tax-reformrelated spending. 5 As such, our equity guidance still favors the Consumer Discretionary, Financials, Industrials, and Health Care sectors, despite the potential for limited labor-market shortages and some higher wage costs emanating from restrictive immigration policies (should they come to pass). Despite the aforementioned implications associated with tighter immigration policies in the U.S., our base-case scenario for 2018 continues to reflect only modestly higher levels of inflation and wage growth in the U.S., even as the positive effects of tax reform make their way through the domestic economy. Therefore, we expect the Federal Reserve to raise interest rates only twice this year, and we have subsequently scaled back our intermediate-term fixed income guidance as we expect the yield curve to flatten as short-term interest rates rise this year. We continue to favor a neutral duration profile (a measure of a bond s interest rate sensitivity) across the yield curve in a well-diversified fixed-income portfolio. 5 Wells Fargo Investment Institute Special Report, Market Implications of Tax Reform, December 27, 2017. 2018 Wells Fargo Investment Institute. All rights reserved. Page 4 of 6

Economic Calendar Date Report Estimate Previous 1/23/2018 Richmond Fed Manufact. Index 18 20 1/24/2018 MBA Mortgage Applications -- 4.10% 1/24/2018 FHFA House Price Index MoM 0.40% 0.50% 1/24/2018 Markit US Manufacturing PMI 55.1 55.1 1/24/2018 Markit US Services PMI 54.4 53.7 1/24/2018 Markit US Composite PMI -- 54.1 1/24/2018 Existing Home Sales 5.70m 5.81m 1/24/2018 Existing Home Sales MoM -1.90% 5.60% 1/25/2018 Advance Goods Trade Balance -$68.5b -$69.7b 1/25/2018 Wholesale Inventories MoM 0.30% 0.80% 1/25/2018 Retail Inventories MoM -- 0.10% 1/25/2018 Initial Jobless Claims 235k 220k 1/25/2018 Continuing Claims 1915k 1952k 1/25/2018 Bloomberg Consumer Comfort -- 53.8 1/25/2018 New Home Sales 675k 733k 1/25/2018 New Home Sales MoM -7.90% 17.50% 1/25/2018 Leading Index 0.50% 0.40% 1/25/2018 Kansas City Fed Manf. Activity 14 14 1/26/2018 GDP Annualized QoQ 3.00% 3.20% 1/26/2018 Personal Consumption 3.70% 2.20% 1/26/2018 GDP Price Index 2.30% 2.10% 1/26/2018 Core PCE QoQ 1.90% 1.30% 1/26/2018 Durable Goods Orders 0.90% 1.30% 1/26/2018 Durables Ex Transportation 0.60% -0.10% 1/26/2018 Cap Goods Orders Nondef Ex Air 0.50% -0.20% 1/26/2018 Cap Goods Ship Nondef Ex Air -- -0.10% 1/29/2018 Personal Income 0.20% 0.30% 1/29/2018 Personal Spending 0.50% 0.60% 1/29/2018 Real Personal Spending -- 0.40% 1/29/2018 PCE Deflator MoM -- 0.20% 1/29/2018 PCE Deflator YoY -- 1.80% 1/29/2018 PCE Core MoM 0.20% 0.10% 1/29/2018 PCE Core YoY -- 1.50% 1/29/2018 Dallas Fed Manf. Activity 25.5 29.7 Source: Bloomberg, as of January 19, 2018 2018 Wells Fargo Investment Institute. All rights reserved. Page 5 of 6

Risk Considerations Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities. Investments in fixed-income securities are subject to interest rate, credit/default, liquidity, inflation and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond s price. Credit risk is the risk that an issuer will default on payments of interest and principal. This risk is higher when investing in high yield bonds, also known as junk bonds, which have lower ratings and are subject to greater volatility. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity. General Disclosures Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. The information in this report was prepared by Global Investment Strategy. Opinions represent GIS opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR 0118-03294 2018 Wells Fargo Investment Institute. All rights reserved. Page 6 of 6