The Federal Reserve's decision Wednesday to keep scaling back its stimulus underscored just how high the bar is for the central bank to budge from its plans for winding down the program this year.
The worst week for the S&P 500 in over a year? Not gonna do it. The sharpest decline in emerging market currencies in five years? Nope. The weakest month of job creation since January 2011? Still, no.
All that volatile economic news amounted to a test of the Fed's conviction in both the new course it has charted and its optimistic forecast for the U.S. recovery. The central bank said it will trim the amount of money it is pumping into the economy from $75 billion this month to $65 billion in February, with similar reductions expected through the year until the program ends entirely. Investors had become increasingly worried that the Fed might pause the drawdown in stimulus, signaling a rough patch in the economy. At the same time, they were panicked at the thought that the central bank might become uncomfortable with the program altogether and pull back more quickly, speeding up the flow of capital out of emerging markets.
But Fed Chairman Ben S. Bernanke has repeatedly argued that economic trouble in developing countries is best managed by the central banks of those countries. So the fact that Turkey's currency slid to record lows against the dollar over the past week is really Turkey's problem – even though it sparked a scare in markets around the world. Indeed, Turkey's central bank responded Tuesday by hiking its main interest rate from 7.75 percent to 12 percent, helping to stem the lira's decline, while the Fed stayed the course in the United States. In other words, Bernanke refused to play chicken with Turkey.
By keeping the taper intact, the Fed seems to be trying to convince the markets that it means what it says. It did not even deign to mention the recent global selloff in the statement it released after its policy committee meeting. And it only briefly acknowledged that labor market data had been "mixed."
That is not to say the Fed can't change its mind. In fact, officials have gone out of their way to emphasize that the timeline will depend on the health of the economy and the reductions are not on a preset course. But that's just an escape hatch to be used in case of an emergency. What the Fed signaled Wednesday is that it's going to take a lot more than a few bad days in the markets to call 9-1-1.