What Set Interest Rates?
It depends on what interest rates we are talking about here.
Short-term and Intermediate-Term Rates
For short-term and intermediate-term interest rates, the Federal Reserve plays a key role because its Federal Open Market Committee meets several times a year and set a target for the Federal Funds Rate. Banks lend their excess reserves other other banks overnight based on this rate. Furthermore, an array of other rates, such as adjustment mortgages, credit card rates, and home equity lines of credit rates, are based on the federal reserve fund rates.
For long-term loan loan rates, there are other important factors, such as expectations for inflation and economic growth. Traders with such expectations buy and sell Treasury bonds thus push their yields up and down. When yields go up, they pull up 30-year mortgages rates, corporate bonds and state and local government bonds rates, and other loans with rates tied to long-term bond yields. In other words, when the Fed raises rates, long term yields don't always rise.
In our next blog post, we will answer the question - what's the difference between interest rates and bond yields?