The G Fund was the best-performing fund in 2018, but its performance may flatten out or slow a bit in 2019, depending on Federal Reserve policy changes

Lyn Alden

January was a very strong month for the TSP, with all funds in the green. The C Fund went up just over 8%, the S Fund jumped over 11.6%, and the I Fund climbed 6.6%. The G Fund was up a fraction of a percent, and the F Fund pushed up 1%.

The G Fund was the best-performing fund in 2018, but its performance may flatten out or slow a bit in 2019, depending on Federal Reserve policy changes.

The G Fund provides an interest rate equal to the average interest rate of all Treasury bonds with more than 4 years of duration. In practice, this tends to correlate very well to 10-year Treasury interest rates.

The Federal Reserve had previously been planning to gradually raise short-term interest rates through 2019, which may have boosted the yields of longer-dated bonds including the G Fund rate. However, a flattening yield curve, high stock market volatility, low inflation, and softening foreign economic data seems to have led the Fed to slow down its rate hike plan.

On January 30th, the Federal Reserve chairman Jerome Powell gave a speech and said that the Federal Reserve would be more patient with regards to further interest rate hikes. Powell also said that the Fed would maintain a substantial portion of its balance sheet intact and would leave open the option of using its balance sheet as a tool for future monetary policy, meaning that they do not rule out future rounds of quantitative easing should they judge the economy to require it.

As of December, the bond market was already projecting flat-to-down short-term interest rates for 2019 and 2020, which was below the moderately higher rates that the Federal Open Market Committee (FOMC) of the Federal Reserve had been projecting.

Image Source: JP Morgan Guide to the Markets

G Fund returns have unfortunately been dwindling for TSP investors since its inception in 1987, and the Federal Reserve’s recent decision to be patient with rate hikes implies that this state of affairs is likely to continue for quite a while.

In the chart below, the blue line represents 10-year Treasury yields (roughly the same interest yield that the G Fund provides over time) and the red line represents the inflation rate.

Chart Source: St. Louis Federal Reserve, BLS

As you can see, gap between the blue line and red line that represents the real inflation-adjusted returns of 10-year Treasury bonds and the G Fund has been shrinking since the 1980’s. In the late 1980’s, G Fund investors received 3-4% annual inflation-adjusted interest. In the 1990’s, this had dwindled to about 2.5-3% on average. Today it’s frequently close to zero.

I combined these lines in the chart below to be clearer. In this chart, the blue line represents the real inflation-adjusted interest rates for 10-year Treasury bonds (and roughly the G Fund) over time:

Chart Source: St. Louis Federal Reserve, BLS

The G Fund still serves as a useful form of protection from volatility but is not offering investors much in the way of real returns over the past decade. Over the past couple months, the Federal Reserve has indicated that they don’t plan to raise rates much unless inflation mandates it, meaning the real inflation-adjusted returns of the G Fund are likely to remain low for the time being.

Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.