Question

Discuss how the bond market reacts when the Federal Reserve increases short term interest rates.

Answer 1

The Fed raises rates to control inflation and lowers rates to stimulate economicc growth.A rise in fed fund rate woukd generally result in bond prices sinking lower.Bonds and interest rate have an inverse relationship.As interest rates increases,bond prices generally fall.By bond price it means previously issued bonds.New bonds are issued with coupon rates in keeping with the current prevailing interest rates.Investors want bonds with a higher interest rate.This reduces the desirability of for bonds with lower rates.Thus price for those bonds goes down to coincide with lower demand.