The TSP bond funds have held up well, but the G Fund is on track to offer interest rates over 30% lower going forward.

Lyn Alden

The stock market continued to slide last week, negatively impacting the TSP equity funds. The Dow Jones Industrial Average has now fallen for six consecutive weeks.

For the full month of May, the G Fund returned 0.21% and the F Fund jumped over 1.7%. The C Fund was down over 6.3%, the S Fund was down just under 7%, and the I Fund was down over 4.6%.


Although the two bond funds have held up well, the G Fund is on track to offer interest rates over 30% lower going forward in the current environment than it did six months ago.

Shrinking Bond Yields

Market participants have generally been de-risking over the past few months, meaning funds are flowing out of stocks and into bonds and other historically lower-volatility assets.

In particular, the demand for U.S. Treasury bonds has been increasing.

When fewer investors are willing to buy bonds, the interest rate increases in order to boost the demand for them. In contrast, when investor demand for bonds increases, it pushes the interest rate down on those bonds. That’s what is currently happening with long-term Treasury bonds; high demand is pushing yields lower.

The G Fund interest rate is equal to the average of all Treasury bonds with a maturity of over 4 years, which in practice correlates closely to the popular 10-year Treasury bond yield. Back in November 2018, the 10-year bond yield was up to 3.24%, and for the next six months up to this writing in early June 2019, the 10-year bond yield has fallen to 2.13%.

Chart Source: St. Louis Fed


As a result, the yield on the G Fund has been shrinking. In November 2018, the G Fund returned nearly 0.26% for the month. In May 2019, the return was down to 0.21% for the month.

If yields do not bounce back from current low levels, we could see G Fund monthly returns down below 0.20% going forward.

The official inflation rate in the United States is around 2% per year currently, so the G Fund just treads water with inflation at this point. In Europe and Japan, government bond yields are zero or negative. The United States currently has the highest bond yields among large developed countries even though the yield is so low by historical standards.

Inverting Yield Curve

We had a normal yield curve last year, meaning that longer-duration Treasury bonds paid higher interest rate yields than shorter-duration Treasury bonds. But as the Federal Reserve has gradually raised short-term interest rates, and as increased market demand has pushed down the yields of longer-term interest rates, the yield curve has inverted, meaning that most longer-duration bonds currently have lower yields than shorter-duration bonds.


Chart Source: MarketWatch

An inverted yield curve like this is unusual and normally precedes an economic slowdown. It is a strong bearish indicator for economic strength and equity returns, although history is not a perfect guarantee for the future.

The bond market is currently factoring in a greater than 80% chance that the Federal Reserve will cut short-term interest rates by the end of the year, which could un-invert the yield curve and result in lower interest rates paid by short-term bonds and bank accounts.

Some analysts expect that during the next U.S. recession, the Federal Reserve is likely to perform a fourth round of quantitative easing, and that yields on U.S. debt might reach zero like most of the rest of the developed world, meaning the G Fund would not have positive returns and would gradually lose purchasing power due to inflation. It remains to be seen if that will be the case or not, but as we stand now, the G Fund interest rate is on the decline.

On the other hand, we could very well see a bounce in Treasury yields in the coming months if some positive economic news or sentiment causes investors to shift back into equities and away from bonds.