You need Identity Protection in order to get the 14-day grace period, and Identity Protection requires an Azure AD Premium P2 license. That's why it's not working.
This is discussed by a content author in this Github issue:
Security defaults will trigger a 14 day grace period for registration after a user's first login and security defaults being enabled. After 14 days users will be required to register for MFA and will not be able to skip.
Conditional Access by itself without Azure Identity Protection does not allow for the 14 day grace period. Identity Protection includes the registration policy that allows registration on its own with no apps assigned to the policy. If a Conditional Access policy requires Multi-Factor Authentication then the user must be able to pass that MFA request.