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brainstorm
#6
Jan20-11, 09:38 PM
P: 1,117
Quote Quote by talk2glenn View Post
This is not quite right, but is a pretty pervasive myth.

What the Fed sets are target rates for things that are determined by the market, including the interest rate on Treasury's (which is a function of their price). It encourages the market to move towards target rates via a basket of powerful tools, but it cannot wave a magic wand and mandate that, say, Treasury bonds trade at a given interest rate.

You're right in principle, though: the Fed does try and maintain (among other things) a target interest rate by manipulating (buying and selling in) the debt market.
Your language is slightly more accurate than mine. My understanding was that if the Fed changes its bond rates to a new rate, all existing bonds will get traded at that rate in anticipation that the price of bonds with different rates would be modified in price according to their term and the total interest projected. So there's no mandate, as I understand it, but it would simply be irrational to buy a 1% bond when 3% bonds are available or sell a 4% bond for less that the comparable earning on a 3% bond. Put more simply, you trade bonds based on the interest earned for the life of the bond, regardless of interest rate, and this makes all bonds comparable to bonds issues at the current interest rate adjusted for term earnings. I'm not sure I'm explaining this right and I may be confusing myself.