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Interest Rates & Term Structureintermediate

What Moves Interest Rates

Interest rates are set where the supply of bonds meets the demand for them. Anything that shifts those curves moves rates: wealth, expected inflation, expected returns, risk, liquidity, and the business cycle. The same logic appears as the supply and demand for loanable funds.

Try it yourself

What moves the bond market

Bond price is on the vertical axis, quantity of bonds on the horizontal. Demand slopes down, supply slopes up, and they cross at equilibrium. Flip a shift factor and watch where the new price settles. Remember the bond yield moves inversely to the price.

Bond priceQuantity of bondsDSP* = 50.0
New bond price (P*)50.0 / 100
Change vs baseline+0.0 pts
No net shift: price unchanged, so the yield is unchanged too.
Shift factors

Why it matters

Bond price and interest rate are two sides of one coin, so explaining the price explains the rate. When buyers want bonds more, the price rises and the rate falls. When issuers flood the market with bonds, the price falls and the rate rises.

Worked examples

Scenario

Expected inflation rises. What happens to interest rates (the Fisher effect)?

Solution

Bond demand falls (real returns look worse) and bond supply rises (borrowing is cheaper in real terms). Both push the bond price down, so the interest rate rises. Higher expected inflation raises nominal rates.

Common mistakes

  • ✗Only the central bank sets interest rates. The central bank strongly influences short rates, but market supply and demand set the broad structure of rates.
  • ✗A booming economy lowers rates. In an expansion, both bond demand and supply rise, and supply usually dominates, so rates tend to rise.

Revision bullets

  • •Rates are set by bond supply and demand
  • •Demand shifters: wealth, expected return, risk, liquidity
  • •Supply shifters: investment opportunities, government deficits, expected inflation
  • •Fisher effect: higher expected inflation raises nominal rates

Quick check

A large rise in government borrowing, all else equal, tends to

Connected topics

Fisher EquationRisk StructureCentral Bank

Sources

  1. Mishkin (2018), Ch. 5
    Mishkin, F. S. The Economics of Money, Banking, and Financial Markets. 12th ed. Pearson, 2018. ISBN 978-1-292-26885-9.
    The supply-and-demand framework for the bond market and the determinants of interest rates.
How to cite this page
Dr. Phil's Quant Lab. (2026). What Moves Interest Rates. Derivatives Atlas. https://phucnguyenvan.com/concept/mb-bond-market
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