Who Determines Rates on Bonds of Varying Maturity

Pondering yesterday's post on Accrued Interest re: implied rate odds and the yield curve got me thinking about the relationship between the fed funds rate and bond yields at its most basic levels. There is an enormous amount of complexity and variety that now goes in to analyzing this relationship, and I wanted to shy away from that at the moment. I thought it would be interesting to take a look at what length of maturity the Fed likes to trade in.

Wish I had some more up-to-date numbers, but this graph will have to do to illustrate the point. Using data from an older FRB document covering the years 1975-1997 it looks at the average maturity of bond portfolios held by the Fed and by the market:


Prior to 1980 the Fed had a longer maturity portfolio than the market, however the 80's saw a rapid turnaround with the market having portfolios of bonds with twice the maturity by 1991 and sustained this trend through 1997. The Fed during this period essentially dealt with 3-year bonds or less. The Fed apparently decided that it would only attempt to influence rates on the short end at let the market make up its mind regarding longer maturities. You can see that anything beyond 5 years is simply the market placing bets amongst itself and taking cues from the Fed on the short end.