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The Federal Reserve uses a dynamic adjustment method to affect the bond market in the U.S. by adjusting rate settings. These adjustments are made by the Federal Reserve's Open Market Committee and represent a long-term strategy to control the economic well-being of the nation. To lower interest rates, the Fed buys bonds which in turn increases the demand for bonds and causes their prices to rise. To raise interest rates, it sells bonds which increases supply and pushes prices lower. This is the main method the Fed uses to maintain liquidity throughout the market.
Bonds are generally issued with a set price which means that the purchase price, interest gained and final cash-out time are pre-determined. Investors in this market understand this, so they attempt to hedge against this volatility. When the Fed lowers interest rates on the discount rate or the Fed funds rate, the possibility of inflation exists. This will affect the overall return the investor gets from the bond. This means that an investor can finance a 30-year Treasury bond and end up with less money upon maturity because of inflation.
This creates an environment in which traders of the T-notes adjust the overall value of the bond. The bond's value changes from day-to-day. The Fed attempts to control this by using its rate settings powers, however, the private market for bonds ultimately decides the overall value of longer-term securities.
