What's next for the Fed as turmoil unfolds

When we last published early Friday, one big question facing financial markets was what the Fed would do at the upcoming policy meeting that starts on March 21. Would officials continue to raise interest rates at the steady, quarter-point pace, or speed back up in the face of hotter-than-expected economic data?

• But in the wake of a few bank collapses, markets are pricing in the possibility that the Fed might not raise rates at all, signaling expectations central bankers may choose to tread lightly.

Why it matters: The massive shift in expectations shows the Fed's new quandary. The stress facing banks may ultimately act as a brake on the broader economy, prompting the need for less aggressive hikes.

• Or alternatively, broader financial stability might lead officials to stiffen their resolve against inflation.

Driving the news: Interest rates have seen a nearly unthinkable move. The yield on the two-year Treasury bond plummeted to 4.01% as of 11:30am ET on Monday, down a massive 100 basis points since Thursday. That partly reflects investors' rush into safe-haven assets.

By the numbers: The probability that the Fed would hold rates at the current level jumped to nearly 30%, while odds officials would hike by a quarter-point rose to 70%, according to calculations based on futures pricing by the CME. Chances the Fed does a half-point hike plummeted to zero, versus a 40% chance as recently as Friday.

• Where the markets anticipate interest rates will ultimately top out is all over the map, setting up a situation in which prices get jolted when officials unveil fresh terminal rate forecasts later this month.

What they're saying: "What's happening could lead to banks suddenly starting to contract credit supply. But that might happen too fast for the Fed's liking," says Jan Groen, chief U.S. macro strategist at T.D. Securities.

• "Despite the fact that they are behind in the fight against inflation, the Fed has also made it clear that they would like not to disrupt the economy too much right — they're looking for [a] soft landing. This is the uncertainty that they're now confronted with, basically overnight."

The bottom line: Much may come down to Tuesday's consumer price index report, which — should it be surprisingly hot — may shift expectations for what the Fed does next.

• We won't hear from Fed officials this week. The standard quiet period ahead of the policy meeting started on Saturday.