Fed Meets In An Increasingly Fragile World

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We at Allianz Global Investors express our deep condolences for the horrific act of terror and hate that occurred in Orlando Sunday. We join the good people of this world in mourning those lost in this senseless violence.

The cloud of geopolitical crises

As we mentioned after last autumn's terrorist attacks in Paris, it is far too early to comprehend all the ramifications of the geopolitical instability across the globe.

However, we do know that this terrorist attack will provide a backdrop to the Federal Open Market Committee (FOMC) meeting this week and then the UK's Brexit vote the following week, adding yet more volatility to already volatile situations. The radicalization of individuals through the internet and social media will remain a key security concern for governments, which are still struggling with how to manage heightened terror threats in open societies.

While the Orlando attack is very unlikely to impact the Fed's decision-making process, it contributes to an overall cloud of geopolitical crises weighing on the world. Russia is suggesting its military will return to the conflict in Syria in a meaningful way, which has the potential to escalate a war that's now in its fifth year. Russia's persistent presence and meddling in the Ukraine is also still a concern. China, meanwhile, continues to flex its muscle in the South China Sea, routinely buzzing US planes and disregarding US admonitions on the territory during annual talks last week.

In South America, Venezuela appears closer to imploding, with recent reports surfacing that its state-owned oil company is delaying payments to the companies it does business with, as the economy runs out of money. Similarly, Brazil is in the midst of a perfect storm: a presidential impeachment process and a serious health crisis as the epicenter of the Zika virus - all while trying to prepare for the Olympics later this summer.

What the Fed will be looking at

While events outside the US will certainly concern the FOMC, we think it more likely that the Fed's attention will be trained on the US economy at this meeting, given recent economic data. As we saw last Monday, the Fed's Labor Market Conditions survey has deteriorated significantly recently. The -4.8 reading for the May Labor Market Conditions Index was the worst we've seen in years - and is the fifth consecutive negative monthly reading. It underscores the anemic non-farm payrolls created for the month of May.

In addition, the most recent data on productivity, which was disappointing, means those American workers, all else being equal, are producing less; this typically should result in companies hiring fewer employees. However it is worth noting that this weakness seems to contrast with recent initial jobless claims, which are shrinking; recent labor market strength can also be seen in continuing claims, which has also moved lower.

To Brexit, or not to Brexit

This recent terrorist attack in Orlando could have a significant impact "across the pond" on the Brexit vote next week.

Brexiteers have attempted to tap into more emotional topics such as terrorism and immigration in their efforts to secure a departure from the European Union (EU). With the Orlando gunman allegedly pledging allegiance to ISIS, UK voters could be frightened into voting for an exit given German Chancellor Angela Merkel's commitment to enabling migration from Turkey and the Middle East to the EU.

For the same reason, the latest terrorist attack could have a significant impact on the presidential election in the US in an already politically-charged election season. While the outcomes remain to be seen, there's at least one thing investors can count on - more volatility ahead!