Traders talk about "the Fed setting rates" as though rates are decided in a room. The Fed sets one specific overnight rate. Everything else — mortgages, corporate debt, the 10-year — is priced by a market.
Understanding that market is what lets you see why rates move even when the Fed does nothing at all.
Here's a question that separates people who understand rates from people who follow them: if the Fed held its policy rate perfectly still for a year, would the 10-year Treasury yield stay flat?
Not remotely. Because most of the rate structure isn't set by the Fed — it's set by supply and demand in the credit market.
Credit and Debt Are the Same Transaction
Two words for opposite ends of one deal:
- Credit is the act of making a loan — the lender's side.
- Debt is owing the asset that was loaned — the borrower's side.
Every loan creates both simultaneously. And like any market, the price gets set where supply meets demand. The price here happens to be the interest rate.
The Loanable Funds Model
Strip the credit market to its bones and you get two forces.
| Side | Who | Where it comes from |
|---|---|---|
| Supply | Lenders | Savings — how much people are willing to lend out rather than spend |
| Demand | Borrowers | Investment — how much businesses and households want to borrow to fund projects and purchases |
Supply slopes upward: higher rates make lending more attractive, so more savings get offered. Demand slopes downward: higher rates make borrowing more expensive, so fewer projects clear the hurdle. Where they intersect is the equilibrium interest rate.
What Happens When Each Side Shifts
This is the part with genuine predictive value, because every macro release you track eventually moves one of these two curves.
| Shift | Effect on rates | Effect on lending volume |
|---|---|---|
| Savings increase | Rates fall | Lending rises |
| Savings decrease | Rates rise | Lending falls |
| Investment demand increases | Rates rise | Lending rises |
| Investment demand decreases | Rates fall | Lending falls |
Notice that falling rates can mean two completely opposite things. Rates falling with lending volume rising means abundant savings — healthy. Rates falling with lending volume falling means collapsing investment demand — a contracting economy where nobody wants to borrow at any price.
Rate direction alone tells you almost nothing. Rate direction plus volume tells you which curve moved, and therefore what's actually happening.
What Drives Each Side
Determinants of Savings (Supply)
Primarily household income. Rising incomes mean more saving, which increases loanable funds, pushing rates down and lending up. Falling incomes do the reverse — and this is one channel through which a weakening labour market feeds directly into credit conditions.
Determinants of Investment (Demand)
Two forces, pulling in opposite directions:
- Cost of capital. The higher the cost of undertaking a project, the fewer projects get pursued, which reduces borrowing demand and pushes rates down.
- Expected return on investment. When businesses expect strong returns, they borrow aggressively to fund expansion — pushing both rates and lending volume up.
Expected ROI is the more volatile of the two, and it's largely a function of business confidence. Which is precisely why sentiment surveys like the NFIB capital spending component and the ISM New Orders sub-index have predictive power over credit conditions — they're measuring the demand curve before it shows up in lending data.
Where the Fed Actually Fits
The Fed doesn't set the loanable funds equilibrium. It intervenes in it — moving the overnight rate, and buying or selling bonds to change the quantity of funds available.
That distinction explains a lot of otherwise confusing market behaviour. Long-term yields regularly move against the Fed's policy direction, because the loanable funds market is pricing expected future savings and investment, not today's policy rate. When the Fed cuts but the 10-year rises, the credit market is telling you it expects stronger future investment demand — and that's a signal worth more than the headline cut.