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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?

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    $\begingroup$ 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 at 15:07
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    $\begingroup$ Unrelated issue: There's no reason to capitalize each letter of "Fed," it's not an acronym. $\endgroup$ – Kch Aug 12 at 17:53
  • $\begingroup$ @Kch You are absolutely right! $\endgroup$ – Ansjovis86 Aug 20 at 19:08
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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).

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  • $\begingroup$ 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 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 at 0:27
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    $\begingroup$ 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 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 at 18:16
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They can also lower the discount window rate. But apparently there's a stigma for banks that use it.

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There's different monetary policy tools. The FED decides the policy rate (Fed funds rate) and discount rate. It also trades short term securities through standard open market operations and bonds through quantitative easing. Previously monetary policy was more about changing the policy rate that's why you were told in school that the FED changes the interest rate. However, due to low interest rates and other restrictions QE or buying and selling bonds (with essentially printed money) has taken an increasingly important role.

Expectations management is also important: forward guidance, or simply telling about future actions, can have strong effects.

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