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Dovish Fed Seen Keeping Lid on Market Worry

Christiana Stawski | Getty Images

With Cyprus creating a new wave of worry, markets will be looking to the Federal Reserve Wednesday to keep a steady hand on the tiller.

At the end of its two-day meeting, the Fed is expected to keep monetary policy unchanged, continuing its super low rates policy and its $85 billion a month in asset purchases.

The Fed is buying mortgage securities and Treasurys in its quantitative easing program, and Fed watchers expect it to stick with its program until the middle of next year, according to CNBC's Fed survey.

"We'll see what happens tomorrow (Wednesday) ," said Jack Ablin, CIO of BMO Private Bank. "If they do nothing…to me that's a license to borrow money and buy stocks." Ablin said the markets have been settling into a pattern where the roughly six percent free cash flow yield on the S&P 500 is higher than the 5.8 percent yield on high yield bonds.

"I think the Fed is going to remain mum and continue to keep the pedal to the metal," he said.

The dovish Fed is also expected to help calm markets that are warily watching Europe. Tiny Cyprus Tuesday rejected a plan to put a levy on bank deposits, required to secure a 10 billion euro bailout. The country's parliament rejected the EU/IMF plan to tax bank depositors and new President Nicos Anastasiades is expected to meet party leaders on Wednesday to explore how to move ahead.

German Finance Minister Wolfgang Schaeuble said after the vote that he regretted the parliament's decision, and without a sound foundation, there can be no aid for Cyprus.

Cyprus is also looking to Russia for help, and its finance minister will hold meetings there Wednesday, reportedly to discuss a plan to share in Cyprus energy production and other deals in exchange for a levy on deposits. Many of the country's bank deposits were made by Russians.

(Read More: Don't Count Cyprus Out of the Euro Just Yet: Traders)

Markets reacted to headlines from Europe Tuesday but in a somewhat muted way in the U.S. session. The Dow ended up 3 at 14,455, and the S&P 500 was down 3 at 1548. The yield on the 10-year was lower, at 1.89 percent late in the day.

"What really bothered me isn't so much the move itself, it was kind of the lack of judgment behind the move that bothered me. How they were willing to put the needs of bond holders ahead of depositors," said Ablin. "Really to me, Cyprus is less the story and the question is does this undermine confident that depositors have in all of their respective (EU) banks."

The euro was a big mover, dropping to $1.28, a four month low.

"I think the next few days are going to be very tricky," said John Briggs, senior currency strategist at RBS. Briggs expects the Cyprus parliament to ultimately adopt a plan, and avoid exiting the euro.

(Read More: Cyprus Bailout 'Disaster' Risks New Euro Crisis)

But as for the Fed meeting, it should be status quo. "I think his press conference is going to be calming over anything else," he said.

"I think after (Fed Chairman Ben) Bernanke and (Vice Chair Janet) Yellen a couple weeks ago spent so much effort calming markets, being dovish, and saying they're not flinching on QE, I don't think Bernanke's going to change that message," he said.

Fed watchers believe the Fed will give a nod to the improving economy but some say the Fed might change its forecast due to the negative impact of the sequester, the automatic spending cuts that went into effect when Congress failed to come up with a spending plan. Others expect it to keep its outlook little changed, since the recent economic data has been improving.

The Fed will release its statement and economic forecasts at 2 p.m., with a press briefing by Bernanke at 2:30 p.m.

Besides the Fed, there are a few earnings releases. Fed Ex, General Mills, and Lennar report earnings before the bell, while Oracle, Herman Miller, Jabil Circuit and Tumi report after the bell.

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • CNBC Personal Finance Correspondent

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.