Geopolitics in the Middle East and Eastern Europe has dominated financial headlines. But investors should focus more on the U.S. recovery and the Federal Reserve 's response as market drivers.
Monetary-policy speeches in normalizing economies such as the U.S. typically sound less dramatic than grand geopolitical tensions, or hand-wringing over slowing giants like the euro zone and China. And even by the standards of such speeches, Fed chair Janet Yellen 's was uneventful. However, for global markets, it sustained a trend that is likely to prove more significant.
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As on previous occasions, Yellen said there was more slack in the U.S. labor market than the standard unemployment rate might indicate. Unless inflation expectations became unanchored, she suggested interest rates would likely stay near zero "for a considerable time" after the imminent end of quantitative easing , and especially if projected inflation dipped below the Fed's target. She discussed a few new notions, such as a unified indicator that might become a helpful barometer for the Fed's labor market views. But she didn't indicate a new direction in her view of the economy or the Fed's monetary response.
No news from Yellen at Jackson Hole may not make for the most exciting headlines. But it is great news in the near term for financial markets. Previous Fed chair Ben Bernanke often used his Jackson Hole speech to hint at future inflection points in U.S. monetary policy - most recently the third round of quantitative easing in 2012.
With Yellen reiterating her accommodative stance, the near-term outlook for riskier assets remains positive. Nursing the world's dominant economy back to health will benefit slowing giants like the euro zone and China and smooth over geopolitical volatility. Not that investors should be terrified by the prospect of tighter policy. Our research shows that markets tend to react to rate hikes up to six months in advance, but that riskier assets like equities and high-yield bonds do not necessarily decline and in fact tend to outperform high-grade bonds over six and 12-month periods. But with Yellen in dovish mode, the forecast is even less volatile.
Although they make for better headlines, geopolitics, the euro zone, and China are unlikely to derail this near-term momentum. This year's geopolitical tensions have focused on markets like Iraq and Ukraine with no global financial significance except for their potential to influence oil prices. But so far, oil prices haven't moved significantly enough to affect the economy. The authorities involved are unlikely to let it do so.
Euro zone economic growth has ground to a halt, but the euro zone is holding together and government borrowing costs in peripheral nations are still low. This means the euro zone is currently stable from a global perspective. China is skillfully walking the tightrope between keeping growth at 7 percent to 7.5 percent a year and cooling the property market, which witnessed its third straight month of declines in July. And even if it wobbles, it has roughly $4 trillion in reserves to recapitalize its financial system, meaning a global systemic shock is unlikely.
This leaves us with the ongoing U.S. recovery - the world's least interesting financial headline but the most potent driver of its financial markets. With Yellen striking a dovish note at Jackson Hole, and with inflation threats low, the global economic and market outlook remains promising. And even if talk of rate hikes intensifies over the next several months, Yellen has told markets she will not hike until the economy and the labor market are ready for it.
For investors, a diversified portfolio of global equities and fixed income should continue to fare well in such an environment.
Commentary by Simon Smiles, chief investment officer for ultra-high net worth at UBS Wealth Management, and Nick Rice, executive director in the CIO office at UBS Wealth Management. Follow UBS on Twitter @UBSamericas.