<blockquote>
<p>Firstly, I'm confused who is doing the borrowing when it comes to interest rates. If I understand correctly, it's commercial banks borrowing from the Fed, right?</p>
</blockquote>
<p>In economy any actor can borrow from another one so unless specified elswehere in the article it is not clear if it is necessarily the Fed rate they are talking about but it could be.</p>
<blockquote>
<p>So when the interest rate goes up, banks borrow less because borrowing is more expensive. When the interest rates go down, banks borrow more because it's cheaper. Is this correct?</p>
</blockquote>
<p>Yes this will generally, ceteris paribus, hold for all borrowers not just banks.</p>
<blockquote>
<p>Secondly, assuming that's accurate, I'm confused what a &quot;government bond&quot; is. I thought a government bond was where you purchased a bond from the government to lend the government money. I thought the government then paid you an interest rate. Is this true?</p>
</blockquote>
<p>This is true although technically speaking bonds do not pay interests but coupons, but then getting \$50 coupon on \$1000 is equivalent of government paying you 0.5% interest.</p>
<blockquote>
<p>Thirdly, if both of these things are true, then I'm confused why government bonds would be affected by interest rates. If the Fed sets an interest rate on how much it charges people to borrow money, why does that affect the desirability of bonds it uses to borrow money?</p>
</blockquote>
<p>As mentioned in the first section from the passage it is not clear if the author was talking about fed interest rate or some other 'prevailing' interest rate. However, let us assume it was Fed's rate.</p>
<p>When banks borrow from Fed it is not just for giggles, they borrow money from fed so they can lend that money to firms and private individuals. Banks earn profit from intermediation margin, that is the difference between interest they pay to Fed or people who deposit money in the banks, and the interest that firms and consumers seeking loan pay. So increase in cost of borrowing from Fed from banks will increase the interest on commercial loans they give out.</p>
<p>Now firms can always either borrow money directly from bank or ask people to lend them money by issuing bonds like government. Since both bank loan and bond issued by the firm are competing financial assets, ceteris paribus, there shouldn't be significant price differential between them. So if the commercial loans are being issued at lets say  10% interest, firm that wants to sell \$1000 exactly at its face value would have to offer \$100 coupon (assuming all else equal, since of course if there are differences in risk etc it will be reflected).</p>
<p>Now government, competes for the same funds, so again all else being equal if firm's A bond has exactly the same risk and all other characteristics as government one, and if the firm A sells bond at  \$1000 face value  with \$100 coupon, government has to match the competition. If it would only offer \$50 nobody would buy the government bond (however, in real life of course government debt is less risky so they can get away with offering lower coupon but the competition will still make sure the difference between the return on those two bonds is just due to differences in risk).</p>
<p>To sum it up, because generally debt instruments compete with each other change in interest rate for the reserves offered by Fed will have to affect all other interest rates in the economy.</p>

CC BY-SA 4.0
2021-09-29T15:18:27.047Z
2021-09-29T15:18:27.047Z
1muflon1
<p>Whenever Fed purchases a financial asset it issues a Fed liability. This is an asset swap for the bank or non-bank that sold the financial asset to the Fed.</p>
<p>Another term for these asset swaps is &quot;portfolio rebalancing&quot;. If Fed unwinds its balance sheet then it would sell financial assets back to other sectors and cancel a corresponding dollar volume of its liabilities which is another asset swap.</p>
<p>Fed can control at least one interest rate when its fed funds liabilities are in shortage or demand by banks and must pay interest on reserves when forced to do large scale asset swaps. The money market interest rates for wholesale borrowing are set by arbitrage off the Fed policy rate but also by emerging and changing customs in the money market dealer networks.</p>
<p>When money and credit markets are functioning well, and the economy is expanding, there is less relative demand for Fed funds or Treasury securities, because financial investors seek to earn the profit or higher rates of interest of risk-bearing instruments. This is called &quot;risk on&quot; in the financial dealer jargon. If the government runs a large deficit and the credit markets are providing funds to expand aggregate demand then the Treasury is forced to pay higher interest if Fed is putting up the short term interest rate in an effort to reduce the rate of aggregate credit expansion. When interest rates rise the old bonds trade at lower price compared to new bonds and investors may try to get ahead of the transition or get stuck with a position based on interest rate risk.</p>
<p>The &quot;risk off&quot; economy occurs when financial investors prefer to hold the federal funds issued by Fed or the Treasury securities issued by the federal government because they hold net asset value better than any real or financial investments when there is asset price deflation and credit contraction. One needs a good model for the roles of various sectors in the economy to explain the complexity of risk on, risk off, and portfolio rebalancing.</p>
<p>In general if short term interest rates go up due to Fed policy then then every bank and non-bank financial intermediary must rollover their short term liabilities as they mature and pay higher interest rates but not every bank or non-bank financial intermediary can be insured against a change in interest rates (interest rate risk) unless the aggregate non-bank sector is taking the loss that would otherwise fall on the financial sector. So your question relates to investor risk-on versus risk-off psychology and to the complex subject of monetary policy transmission and interest rate arbitrage.</p>

CC BY-SA 4.0
2021-09-29T17:37:56.237Z
2021-09-29T17:37:56.237Z
SystemTheory
<p>I was reading the &quot;<a href="https://seekingalpha.com/news/3745597-nasdaq-attempts-rebound-after-brutal-selloff-on-wall-street" rel="nofollow noreferrer">news</a>&quot; and saw this:</p>
<blockquote>
<p>Inflation and the prospect of higher interest rates are prompting
investors to dump government bonds and reposition their stock
portfolios.</p>
</blockquote>
<p>I'm confused about a couple things.</p>
<p>Firstly, I'm confused who is doing the borrowing when it comes to interest rates. If I understand correctly, it's commercial banks borrowing from the Fed, right? They pay an interest back on top of the principal. So when the interest rate goes up, banks borrow less because borrowing is more expensive. When the interest rates go down, banks borrow more because it's cheaper. Is this correct?</p>
<p>Secondly, assuming that's accurate, I'm confused what a &quot;government bond&quot; is. I thought a government bond was where you purchased a bond from the government to lend the government money. I thought the government then <em>paid you</em> an interest rate. Is this true?</p>
<p>Thirdly, if both of these things are true, then I'm confused why government bonds would be affected by interest rates. If the Fed sets an interest rate on how much it charges people to borrow money, why does that affect the desirability of bonds it uses to borrow money? Aren't it's lending and borrowing two distinct things? Why would its lending interest rate affect the desirability of the bonds it uses to borrow money? In other words, aren't these two different things? The Fed lends banks money. So that's one side of it's responsibilities. But the Fed also borrows money from people, another thing it does. Why are these two connected?</p>

CC BY-SA 4.0
2021-09-29T21:49:30.993Z
There are many issues here, but at present commercial banks lend to the Federal Reserve (known as excess reserves).  Interest rates are set by a combination of supply, demand and Fed policy making, with the last of these trying to influence whether individuals and companies borrow more or less.   If the Fed want to influence interest rates then it competes with private sector borrowing and lending so the two are linked
Henry
<bonds>
Why do bond prices reflect changing interest rates by the Fed if the bonds are already sold?
Stan Shunpike
# Why do bond prices reflect changing interest rates by the Fed if the bonds are already sold?

(Asked by: username_0 on 2021-09-29)

I was reading the "[news](https://seekingalpha.com/news/3745597-nasdaq-attempts-rebound-after-brutal-selloff-on-wall-street)" and saw this:

> Inflation and the prospect of higher interest rates are prompting
> investors to dump government bonds and reposition their stock
> portfolios.

I'm confused about a couple things.

Firstly, I'm confused who is doing the borrowing when it comes to interest rates. If I understand correctly, it's commercial banks borrowing from the Fed, right? They pay an interest back on top of the principal. So when the interest rate goes up, banks borrow less because borrowing is more expensive. When the interest rates go down, banks borrow more because it's cheaper. Is this correct?

Secondly, assuming that's accurate, I'm confused what a "government bond" is. I thought a government bond was where you purchased a bond from the government to lend the government money. I thought the government then *paid you* an interest rate. Is this true?

Thirdly, if both of these things are true, then I'm confused why government bonds would be affected by interest rates. If the Fed sets an interest rate on how much it charges people to borrow money, why does that affect the desirability of bonds it uses to borrow money? Aren't it's lending and borrowing two distinct things? Why would its lending interest rate affect the desirability of the bonds it uses to borrow money? In other words, aren't these two different things? The Fed lends banks money. So that's one side of it's responsibilities. But the Fed also borrows money from people, another thing it does. Why are these two connected?

**Tags:** bonds
> **Comments:**
> **username_1**: There are many issues here, but at present commercial banks lend to the Federal Reserve (known as excess reserves).  Interest rates are set by a combination of supply, demand and Fed policy making, with the last of these trying to influence whether individuals and companies borrow more or less.   If the Fed want to influence interest rates then it competes with private sector borrowing and lending so the two are linked  

---

## 2 answers

### Answer by username_2 on 2021-09-29. Score: 0

> Firstly, I'm confused who is doing the borrowing when it comes to interest rates. If I understand correctly, it's commercial banks borrowing from the Fed, right?

In economy any actor can borrow from another one so unless specified elswehere in the article it is not clear if it is necessarily the Fed rate they are talking about but it could be.

> So when the interest rate goes up, banks borrow less because borrowing is more expensive. When the interest rates go down, banks borrow more because it's cheaper. Is this correct?

Yes this will generally, ceteris paribus, hold for all borrowers not just banks.

> Secondly, assuming that's accurate, I'm confused what a "government bond" is. I thought a government bond was where you purchased a bond from the government to lend the government money. I thought the government then paid you an interest rate. Is this true?

This is true although technically speaking bonds do not pay interests but coupons, but then getting \$50 coupon on \$1000 is equivalent of government paying you 0.5% interest.

> Thirdly, if both of these things are true, then I'm confused why government bonds would be affected by interest rates. If the Fed sets an interest rate on how much it charges people to borrow money, why does that affect the desirability of bonds it uses to borrow money?

As mentioned in the first section from the passage it is not clear if the author was talking about fed interest rate or some other 'prevailing' interest rate. However, let us assume it was Fed's rate.

When banks borrow from Fed it is not just for giggles, they borrow money from fed so they can lend that money to firms and private individuals. Banks earn profit from intermediation margin, that is the difference between interest they pay to Fed or people who deposit money in the banks, and the interest that firms and consumers seeking loan pay. So increase in cost of borrowing from Fed from banks will increase the interest on commercial loans they give out.

Now firms can always either borrow money directly from bank or ask people to lend them money by issuing bonds like government. Since both bank loan and bond issued by the firm are competing financial assets, ceteris paribus, there shouldn't be significant price differential between them. So if the commercial loans are being issued at lets say 10% interest, firm that wants to sell \$1000 exactly at its face value would have to offer \$100 coupon (assuming all else equal, since of course if there are differences in risk etc it will be reflected).

Now government, competes for the same funds, so again all else being equal if firm's A bond has exactly the same risk and all other characteristics as government one, and if the firm A sells bond at \$1000 face value with \$100 coupon, government has to match the competition. If it would only offer \$50 nobody would buy the government bond (however, in real life of course government debt is less risky so they can get away with offering lower coupon but the competition will still make sure the difference between the return on those two bonds is just due to differences in risk).

To sum it up, because generally debt instruments compete with each other change in interest rate for the reserves offered by Fed will have to affect all other interest rates in the economy.


---

### Answer by username_3 on 2021-09-29. Score: -1

Whenever Fed purchases a financial asset it issues a Fed liability. This is an asset swap for the bank or non-bank that sold the financial asset to the Fed.

Another term for these asset swaps is "portfolio rebalancing". If Fed unwinds its balance sheet then it would sell financial assets back to other sectors and cancel a corresponding dollar volume of its liabilities which is another asset swap.

Fed can control at least one interest rate when its fed funds liabilities are in shortage or demand by banks and must pay interest on reserves when forced to do large scale asset swaps. The money market interest rates for wholesale borrowing are set by arbitrage off the Fed policy rate but also by emerging and changing customs in the money market dealer networks.

When money and credit markets are functioning well, and the economy is expanding, there is less relative demand for Fed funds or Treasury securities, because financial investors seek to earn the profit or higher rates of interest of risk-bearing instruments. This is called "risk on" in the financial dealer jargon. If the government runs a large deficit and the credit markets are providing funds to expand aggregate demand then the Treasury is forced to pay higher interest if Fed is putting up the short term interest rate in an effort to reduce the rate of aggregate credit expansion. When interest rates rise the old bonds trade at lower price compared to new bonds and investors may try to get ahead of the transition or get stuck with a position based on interest rate risk.

The "risk off" economy occurs when financial investors prefer to hold the federal funds issued by Fed or the Treasury securities issued by the federal government because they hold net asset value better than any real or financial investments when there is asset price deflation and credit contraction. One needs a good model for the roles of various sectors in the economy to explain the complexity of risk on, risk off, and portfolio rebalancing.

In general if short term interest rates go up due to Fed policy then then every bank and non-bank financial intermediary must rollover their short term liabilities as they mature and pay higher interest rates but not every bank or non-bank financial intermediary can be insured against a change in interest rates (interest rate risk) unless the aggregate non-bank sector is taking the loss that would otherwise fall on the financial sector. So your question relates to investor risk-on versus risk-off psychology and to the complex subject of monetary policy transmission and interest rate arbitrage.


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