The Federal Reserve historically controls overnight lending rates by increasing or decreasing the flow of Treasury Notes:

     -Historically, when rates need to go lower the Fed buys back from the market a swath of existing Treasury Notes, therefore decreasing market liquidity and increasing the existing note values. By increasing the value of the note the reaction is for the yield (interest rate) to be automatically decreased. Lower interest rates come from less notes in circulation.

     -Historically, when rates need to go up the Fed sells more Treasury Notes, therefore reducing existing note values and increasing the yield (interest rate). That move makes more money available to be lent out into the economy, it increases the yield on the existing notes in circulation, and automatically increases overall market interest rates.

     -In a final gesture, the Fed should look to be banking the cash received from the sale of those notes into the Reserves, so it can then be used in the next cycle of rate changes.

That may be the historical way that the Fed controls interest rates, but the fly in the administration (Treasury Dept. and Federal Reserve) ointment is the fact that there has never been this amount of notes coming to market and being made available. The constant flow of new notes is devaluing the existing, and automatically lifting Treasury yields.

At a time that the Fed is absorbing new notes being printed by the Treasury, so that the Stimulus packages can be put into action and cash created to invest as the Administration wishes, the automatic response is for 10 year yields to rise. The 10-year treasury note has the greatest impact on the U.S. economy due to its influence on long term interest rates.

While the Federal Reserve controls the overnight rate, interest rates paid on long term financing for capital goods, as well as the housing market, are established by asserting a premium over the 10-year Treasury Note.  In other words, whatever the 10 Year Note is worth determines the rates for mortgages, investments and loans that are set from that starting point.

U.S. bond traders are indicating that they feel the Fed is withholding vital information regarding the danger of the U.S. economy not easily coming out of the recessionary phase. There has been no public announcement of any exit strategy to try to unwind the ever-increasing yield (read mortgage, credit card, auto, commercial real estate, borrowing costs), that is creating massive spreads in the value of insuring against default on the notes (read credit default swaps), and the cost of banks doing business with each other (read LIBOR, the London Inter Bank Offered Rate).

The Usd is finding buyers as equity markets go lower because of the near 4% interest rate return that can be locked in because of the record number of new notes coming to auction again this week from the Treasury. The fact that the Fed has no choice but to buy back any amount that the market will not bid freely on is creating the higher rates that the administration wants to reduce, in order for the economy to more easily grow.

The Fed is doing it's job of creating liquidity, the Treasury is doing it's job of creating government debt and generating cash, and the market is doing it's job of selling equities that must look expensive compared to an asset class (Treasuries) that virtually guarantees a 4% rate over each of the next ten years. Take out the cost of insurance that the U.S. government stays solvent, and it may be more easily seen why, ahead of earnings season and massive note auctions, the Usd is getting bought.

The question we have, and it may be us not having this aligned after 30 years of Forex trade, is, if this statement is true;

     -In a final gesture, the Fed should look to be banking the cash received from the sale of those notes into the Reserves, so it can then be used in the next cycle of rate changes.

...how can it be going straight into the economy with only 10% of it held back as a Reserve (read Fractional Banking), and forward commitments still be able to be met?

If there are no no cash Reserves getting built from the sale and part buy-back of new notes, what will be used to stimulate the next business cycle drop. And, more importantly, once the required amount of notes have flooded the market, and yields have exploded, how is the Fed going to repatriate interest rates?

All may be revealed on Wednesday, but if it is not the answer that the market wants to hear we may be seeing huge moves either side of the Usd as the recent channel ranges are tested, both long and short. The reason is that times like these are rare indeed, and in reality all that can be followed with certainty is the desire to own global equities. In the ultimate market for revealing fear of loss and greed, we will get to see the ultimate dollar valuation game play out.

Long Stocks = Short Treasury Yields = Lower Dollar, and vice versa.

Another relationship of note (no pun intended) is between the bond's price and the interest rate, or premium it offers at any time. It's an inverted relationship; when bond prices increase the yield (interest rate) moves lower, and vice-versa. This all comes from the fact that at maturity repayment of the principle is paid at par value, and not at bond's market price. Par value = Current Interest Rate/Price

     -A $1000 10 year Treasury Note, with a 4% Interest Rate; $1000 x 4% = $40 guaranteed a year, for 10 years

     -If the market price of the note goes down, because of increased amount of notes hitting the markets, to $500 for example, then the interest rate math changes because the same $1000 bond with a 4% interest rate is still guaranteed to pay 4% a year.

     -Now that it has an open market value of $500, and still returning $40, the interest rate, or Par, is now 8% for as long as the note value holds $500.

After these results, it's pretty clear that the best way to trade bonds is usually during recession times, when bond prices increase due to repeated rate cuts, and in times of equity selling. The variable here is the unknown exit strategy for the fed to contain interest rates, and that is creating fear of loss, sideways forex trade, and volatility that has no release valve. Roll on Wednesday.