In calmer waters, Bernanke hands Fed to Yellen
After eight years of mostly dealing with crisis or its aftermath, Chairman Ben Bernanke will hand his successor a Federal Reserve steering a course toward more normal times.
As evidence of that, the Fed is expected to announce Wednesday afternoon that it will continue to taper its $75 billion a month bond-buying program by a second $10 billion, split evenly between mortgages and Treasury securities.
"We expect $10 billion tapering tomorrow [Wednesday] and $10 billion at each Fed meeting until the Oct. 29 Fed meeting, when the last reduction is expected to take place," said Tony Crescenzi, senior portfolio manager at Pimco.
The washout in emerging markets has had some traders questioning whether the central bank would proceed with its plan to trim bond purchases, but most Fed watchers expect it to continue at the current pace. The Fed has said any tapering is dependent on economic and financial conditions.
"The threshold for increasing and decreasing the tapering is very high because accelerating tapering would bring forward interest rate hike expectations, and the Fed would almost certainly not want that, especially with inflation low," Crescenzi said. "Reducing the cuts would go against all the reasons the Fed tapered in the first place."
The Fed's statement, to be released at 2 p.m. ET, will also be key for what it says about the economy. Some expect it give a nod to improved momentum in the second half of last year but also to note that unusual cold and snow across the country could temporarily disrupt economic activity.
"Will they take note of the shakiness in the emerging markets?" said Art Cashin, director of floor operations at UBS. "It's a very tricky game. They all universally realize the law of diminished effects has taken over completely, and at the same time they know it's the lucky rabbit's foot to a lot of people. They don't have a press conference, so the wording of that statement has to be carefully honed.
"I think we could get enormous volatility at 2 p.m.," Cashin said.
The selling in emerging markets took off last week after China manufacturing data showed a contraction in activity, spurring concerns about global growth. At the same time, certain vulnerable emerging markets have been attempting to fight inflation and are shouldering high debt burdens as their currencies weaken.
(Watch: Fed Survey: S&P 500 outlook)
Turkey soothed some of the turbulence Monday, when its central bank called an emergency meeting. The outcome of that meeting, held Tuesday, had an immediate positive effect on markets. U.S. stocks closed higher, with the S&P 500 up 10 at 1,792.
Bernanke's final day at the Fed is Friday, when he hands the chairmanship to Vice Chair Janet Yellen. She becomes the 15th chair and the first woman in the role. While perceived by some as even more dovish than Bernanke, she is not expected to veer from the Fed's unwinding of its unusual quantitative easing program.
That program, which has been criticized for potentially encouraging asset bubbles, is also a centerpiece of Bernanke's legacy as a Fed chairman who used extraordinary means to save the economy and revive it after the financial crisis.
Another key Fed policy is forward rate guidance, and traders are watching for any nuance in how the Fed refers to that in its statement. The Fed continues to keep its target fed funds rate at zero, and convincing the market that rates will remain low for a long time, even with tapering, is one of the challenges Yellen will inherit.
"There were moments in his tenure in which your ATM card might not have worked," said Ian Lyngen, senior Treasury strategist at CRT Capital. "I think it's really, really easy to look smart when you're asking the question or criticizing, but there are a lot of hard choices Bernanke made. He helped the economy survive, and the biggest risk was that inflation would take off. … He made a bet and was willing to cover his bet if it went the wrong way, and it didn't."
(Watch: The Fed and income Inequality)
But, he said, "he may have created some bubbles we don't know about."
Lyngen said the Treasury market has already priced in the next taper and may trade more in reaction to emerging markets ahead of the Fed meeting.
"I think that [Turkey] will set the tone for risk assets, and the Treasury market will take its direction accordingly," he added.
A $15 billion auction of the new, floating-rate 2-year Treasury note also will be held Wednesday.
There are dozens of earnings reports Wednesday, including Boeing, Chrysler/Fiat, Novartis, Dow Chemical, Canadian Pacific Railway, Southern Co., Biogen Idec, Marathon Petroleum, JetBlue, Nintendo, Valero,Tupperware, WellPoint Health and Hess before the opening bell.
(Watch: The Fed and emerging markets)
Late-day reports are expected from Facebook, Las Vegas Sands, Qualcomm, Citrix, Lam Research, Murphy Oil, Fortune Brands Home & Security, International Rectifier, Vistaprint, Astoria Financial and Flextronics.
There are weekly mortgage applications, announced at 7 a.m. ET, and oil inventory data at 10:30 a.m.
—By CNBC's Patti Domm. Follow her on Twitter @pattidomm.