The Fed carried on with its tapering campaign at the conclusion of the Federal Open Market Committee meeting on Wednesday, slicing another $10 billion off of monthly purchases, and making no mention of the impact of a nascent crisis in emerging markets.
The statement accompanying the decision was reasonably upbeat, and carried no mention of recent upsets in emerging markets as a possible factor in their thinking. The Fed said the economy "picked up", that the labor market indicators were "mixed" but showing "further improvement" and that household spending and business investment had advanced "more quickly".
All in, this was somewhere between a gentle upgrade and on par with their December statement.
Combine that with no dissenting votes and you have the Fed sending out terrible signals not just for emerging markets, but for riskier investments generally. The Fed is apparently not made afraid by what it sees in emerging markets, and seems comfortable with the negative knock-on consequences for markets generally.
That is the right call, but not what you want to hear if you are long riskier equities. And indeed not only did emerging market currencies and other assets fall after the announcement, but U.S. shares accelerated an earlier slide.
The Fed's moves today are negative for equities and riskier assets like emerging markets in two ways.
First, on a fundamental basis, buying fewer bonds means there are fewer bond investors who now have cash and face a decision on where to put it. That tightens conditions generally, and should, all else being equal, hurt investments in growing proportion to their riskiness.
Secondly, the fact that the Fed has finally met a selloff it doesn't mind is significant. Not only did it pay attention to the market volatility caused by the euro zone crisis, it delayed the taper after a run-up in bond interest rates over the summer. Now, having started the taper, and seeing mixed but what it sees as update data, it seems resolved to carry on even if markets don't like it.
OF GORILLAS AND MONKEYS
Specifically, a Federal Reserve that is buying less is creating tougher conditions for emerging markets, particularly those like Russia, South Africa and Turkey which haven't used the QE years to get their houses in order. So far, most of the damage has been concentrated on those which need to attract capital, but in recent days virtually all have been under pressure, with the notable exception of debt from some thinly traded frontier emerging markets.
More expensive capital is bad news for emerging markets, but not bad enough for the global economy, at least yet, to force a re-think about the pace or appropriateness of the taper.
For their part, targeted emerging market central banks have shown a willingness to use monetary policy to defend their currencies, but with decidedly mixed results. Turkey on Tuesday hiked key rates by 4.5-5.5 percentage points, taking its overnight rate to 12 percent, only to see selling pressure resume just hours later. India's central bank hiked by 25 basis points, the South African Reserve Bank raised by 50.
Those moves proved far less important than what the Fed did, and what it appears to believe.
The hope had been, among some investors at least, that a downdraft in emerging markets would be disruptive enough, like the euro zone crisis was, to merit a nod from the Fed.
You'll remember back in 2011 and for some time afterwards that the Fed statement went with standard language that "strains in global financial markets continue to pose significant downside risks to the economic outlook."
That helped matters in the euro zone, easing by a small amount the selling pressure on weak sovereigns. It also helped to minimize a feedback loop in which euro zone selloffs were causing U.S. ones. No such luck this time.
Europe was a 400-lb gorilla - big, ugly and scary enough to influence policy. Emerging markets right about now are more like a 40-lb monkey, noisy and capable of flinging some unpleasant stuff around but not of prime importance for the Fed.
That's bad news for U.S. equities because it sends the message that this week's selloff is acceptable.
Look for more of the same.