How has the narrative around Fed policy changed?

The Fed has been on pause since its last hike in July 2023, marking seven consecutive months that it’s held the benchmark funds rate steady in a 5.25–5.50% range. Markets, however, have continued to search for direction in the near-term outlook for monetary policy.

From mid-summer to last fall, the “higher for longer” narrative dominated rate forecasts, as economic activity continued to defy expectations to the upside. A dramatic shift occurred in October when the Fed explicitly acknowledged that rate cuts could be in their near-term playbook. The probability of a March 2024 rate cut dramatically increased from less than 10% in early October to about 75% by early January, prompting a strong close to the year for bonds as long-term rates fell sharply. In the last six weeks, that narrative has backpedaled amid hotter-than-expected inflation readings and a remarkably steady labor market. The probability for a March cut has consequently fallen back to below 10%, completing a roundtrip in expectations. Rates across the yield curve have edged a bit higher as a result, representing a near-term headwind for bonds.

Why does this matter? With a March cut now seemingly off the table, it’s a reminder of how quickly narratives — and investor sentiment — can change. Monetary policy matters, but it’s just one of many variables impacting markets over time and predicting near-term shifts is as difficult as timing the market. Investors are best served keeping an eye on the longer term. Over time, coupon yield matters much more than short-term rate volatility.