It’s a common misconception that the Federal Reserve controls every aspect of the U.S. economy. Although the Fed certainly has a say in how money moves throughout the country, it’s important to recognize that there’s one major financial component that lies outside its purview: the bond market.
While the Federal Reserve does control the amount of money in circulation by manipulating interest rates, it has no say in the bond market. In this scenario, it is the bond market — and not the Fed — that is ultimately responsible for setting the rate of interest on a given bond.
Bonds are considered to be low-risk investments, and investors purchase them when they’re looking to get a steady return on their money. To do this, they rely on the bond market, which is where investors buy and sell different types of bonds in order to reap the benefit of potential interest payments from the bonds they purchase.
The bond market is an incredibly important piece of the financial puzzle and it can be highly influential. In a nutshell, when the bond market’s demand for bonds increases, it typically causes interest rates (and thus the cost of borrowing money) to drop.
On the other hand, if the bond market’s demand weakens, it causes interest rates to rise and can seriously affect how much money individuals and businesses can borrow. This makes the bond market particularly important — so even if the Federal Reserve is a powerful entity, it doesn’t have the same influence as the bond market.
Ultimately, it’s important to recognize that while the Federal Reserve does have a great deal of influence over the U.S. economy, the bond market still carries considerable weight. By understanding the different pieces in play, it’s easier to see why things occur the way they do in the world of finance.