| Fed sets up very short term interest rates - specifically, overnight lending. It certainly affects longer-term rates, but only indirectly. In effect, the lending rate for 10 year bonds, say (a common benchmark duration) is set entirely by the market. These are closely related - they operate in the same space - but are in principle independent decision-makers. As to bond yields vs bond prices, t is easiest to see for new bonds - sold directly by the US govt. Unlike consumer loans, with bonds you know exactly how much you get repaid - periodic coupon and maturity. The variable is the price today paid for the bond. The government hopes to achieve a high price, raising as much cash as it can today (for the same future repayment cash flow), i.e. a low interest rate. If the buyers of bonds - lenders - show up in small numbers, there is weak demand to buy, and the bond price is low. This translates to a high rate of interest - for a smaller upfront loan, you get more repayment down the line. The same mechanism works in secondary markets - bond owners trading with each other. In terms of how this affects the decision-making by the Fed - in principle, not at all. Fed is free to do whatever the like. But in practice, Fed is bound by the same forces as the bond traders, and bond yields are going up suggests the Fed will likewise have to raise rates. Or bond yields go up in anticipation to the Fed having to raise rates, etc. |