The new year has brought with it a tale of two bond markets, to say the least. In January, the U.S. Treasury (UST) arena managed to put a full year’s rally into one month. Unfortunately for the fixed income investor, the month of February has felt like a full year’s bear market in less than 28 days.

Needless to say, this changing dynamic within the money and bond markets has brought with it a visible transformation in the Fed outlook as well. One gauge of market sentiment into what is expected from the Federal Open Market Committee (FOMC) is Fed Funds Futures, specifically the implied probability rate. While this measure can be useful to determine where the market’s mindset regarding the Fed is at, a word of caution is certainly advised. Indeed, the track record between expectations for Fed Funds and where the actual rate ends up leaves something to be desired.

Nevertheless, we thought it would be useful to provide our readers with an update on how sentiment has changed during the first two months of the year. The turning point was most assuredly February 3, the day the Bureau of Labor Statistics released its blockbuster jobs report. As a result, we look to the day before the employment data release, February 2, as our line of demarcation. And what a line it is.

Here’s some perspective to consider: On February 2, the implied probability for Fed Funds had the terminal rate coming in at just under 4.90% for both the May and June FOMC meetings. Given the current target band of 4.50%–4.75%, this “implied” that only one more quarter-point rate hike was expected, and that would occur at the upcoming March convocation. Perhaps more importantly, the implied probability rate dropped to 4.17% by January 2024, suggesting two rate cuts would be forthcoming by the end of this year!

So, now let’s turn our attention to the current outlook. As of this writing, the peak terminal rate has risen to essentially 5.40% by July, or a swing of 50 basis points (bps) from just about four weeks ago. This level would imply that three more rate hikes will be implemented (assuming 25-bp increments) at the March, May and June FOMC gatherings. However, the potential rate-cut scenario has gotten even more interesting. Presently, the implied probability rate for January of next year has now increased to 5.15%, or nearly 100 bps above the early February reading.

What, if any, conclusions can investors draw from this dramatic shift in sentiment? Certainly, one consideration we’re finding out is that the UST market was priced for perfection. In other words, the rally to begin this year brought yield levels down to where there was no room for error if economic and/or inflation data didn’t match expectations, let alone change the whole narrative the way they did. Secondly, the market’s expectations for the Fed were too rosy as well. Although we never really saw the FOMC meeting earlier this month as revealing anything groundbreaking, it appeared as if the money and bond markets were looking for dovishness in any way they could find it.

Now we’re back to square one in some sense. Future Fed policy decisions and UST yield movement will remain highly data-dependent. In January, the bond market was operating under the adage of “buying on any price weakness,” but now the mantra seems to be “selling on strength.” For some strange reason, we have the feeling this could change yet again later this year.