3
$\begingroup$

I would just like to confirm my understanding of how the FED controls interest rates. In my view there's no such thing as changing an interest rate. Because rate/yield is just an effect of price action.

So when the FED 'cuts rates', it starts buying more bonds. When the FED does a rate hike, it sells bonds. It's just simply supply and demand affecting yield.

So also the explanation of let's say 'a new bond being in town' with a higher yield is not right in my view. In general there's a dumping of bonds increasing yield over the board.

Can anyone confirm?

Improve this question
$\endgroup$
3
  • 2
    $\begingroup$ The fed doesn't necessarily have to buy or sell anything. Just them announcing a policy change can prompt other market participants to do it for them. If the jawboning announcement doesn't get the job done, than the fomc will actively buy/sell. $\endgroup$
    – amdopt
    Aug 12, 2020 at 15:07
  • 1
    $\begingroup$ Unrelated issue: There's no reason to capitalize each letter of "Fed," it's not an acronym. $\endgroup$
    – Kch
    Aug 12, 2020 at 17:53
  • $\begingroup$ @Kch You are absolutely right! $\endgroup$
    – Ansjovis86
    Aug 20, 2020 at 19:08

2 Answers 2

Reset to default
1
$\begingroup$

The Fed announces targets for where they will push prices with their (effectively unlimited) funds. So yes, they do in effect announce rate cuts. Furthermore, they often cut or raise rates on the discount rate, the rate at which they lend to banks, when they cut or raise the Fed Funds rate target. They may also lengthen or shorten the discount window (the length of time they will lend for).

Improve this answer
$\endgroup$
4
  • $\begingroup$ Yes they announce them. But the only thing they can do is buy or sell. The rate cut is the effect. The buying is the act. That's the point I want to make. $\endgroup$
    – Ansjovis86
    Aug 11, 2020 at 22:30
  • $\begingroup$ Then your point is pointless semantics. "But the only thing they can do is buy or sell"? With unlimited funds, that is everything -- one of the most powerful forces in financial markets. $\endgroup$
    – kurtosis
    Aug 12, 2020 at 0:27
  • 1
    $\begingroup$ Maybe for you it was obvious, but in school I was taught that interest rates affect price. But it is exactly the other way around. I understand economics much better when buying/selling comes before interest rate. It's not semantics. It is the order in which things happen. $\endgroup$
    – Ansjovis86
    Aug 12, 2020 at 7:04
  • $\begingroup$ Benchmark interest rates affect what we think is a correct value for present valuing cashflows. However, price comes from people trading and implies rates. Sorry if your professor did not make that clear; that was a mistake on their part. And it is semantics because the Fed announces their target and then defends it -- so the change in target happens before buying and selling. They also explicitly change their lending discount rate. $\endgroup$
    – kurtosis
    Aug 12, 2020 at 18:16
0
$\begingroup$

They can also lower the discount window rate. But apparently there's a stigma for banks that use it.

Improve this answer
$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.