Market Insider

'Helicopter Ben' expected to keep Fed tapering at final meeting

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The Fed is expected to move forward with a $10 billion taper of its bond-buying program, despite market talk that a shakeout in emerging markets could give it pause.

Some Fed watchers do not see the selloff as an issue the Fed will even comment directly on in its 2 p.m. ET statement Wednesday afternoon, though it will likely be discussed by the members of the Federal Open Market Committee.

Emerging markets were rattled again Wednesday after rebounding late Tuesday and early Wednesday on Turkey's surprisingly sharp rate hike. But the magnitude of the hike, nearly 5 percentage points to 12 percent—raised concerns that the increase in rates will hurt the country's economy and defeat the effort to strengthen the currency.

"Now it raises questions about the whole strategy," said Marc Chandler, chief currency strategist at Brown Brothers Harriman. "I think people are saying the Fed may not taper this afternoon." Even so, Chandler said he expects the Fed to announce a second tapering, taking its monthly bond buying to $65 billion, in part because of the momentum in the U.S. economy.

Chandler also said the Fed would lose credibility if it does not taper, and it would also hurt the credibility of next Fed chair Janet Yellen even before she takes on that role.

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The Fed is expected to cut its quantitative easing program back evenly between mortgages and Treasury securities.

"We expect $10 billion tapering ... 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.

A CNBC survey showed 87 percent of fund managers surveyed expect the Fed to taper by an average of $9.87 billion at this month's meeting, roughly matching the $10 billion reduction, from $85 billion to $75 billion a month, announced after the December meeting.

Seventy-two percent of the survey's respondents expect the Fed to announce an average $10.65 billion reduction after each of the rest of its meetings this year.

The Fed has said any tapering is dependent on economic and financial conditions, and economists say the Fed has to consider strong momentum in the second half of last year. Fourth-quarter GDP is expected to show more than 3 percent growth when it is reported Thursday.

But the Fed will also be looking at whether the poor December jobs report, a drop in new home sales and this week's surprisingly weak durable goods as well as other data signal a weakening in the economy.

"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 will also be key for what it says about the economy, and some expect it could comment on possible economic headwinds from the unusual cold and snow across the country.

"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.

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Fed Survey: Expectations for tapering
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Fed Survey: Expectations for tapering

Robert Sinche, global head of currency strategy at Pierpont Securities, said the Fed tapering is not likely to be affected by what is currently going on in emerging markets, but that could change if it begins to spread.

"Historically the Fed has not wanted to acknowledge responsibility for issues in foreign countries," said Sinche. "I don't think they'll highlight Turkey or this or that. They monitor it in terms of spillover effect on financial conditions. Everybody's trying to blame the Fed for the problems in the emerging markets. The last thing the Fed wants to do is mention emerging markets."

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)

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.

Bernanke won the nickname "Helicopter Ben" after he referred to a statement by Nobel economist Milton Friedman about fighting deflation by using a helicopter drop of money.

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."

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But, Lyngen 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.

(Watch: The Fed and emerging markets)

—By CNBC's Patti Domm. Follow her on Twitter @pattidomm.