Forty years ago, I was taught in business school that interest rates represent the “price of money”. Every commodity in the market has a price. The price of gold, wheat, soybeans, pork bellies, and even money, all these commodities have a “price”. The “price of money” is interest rates. The other thing I learned in business school was that, in a free market, government should never try to set the price of any commodity, because this will ultimately result in deficits or surpluses in the markets. Graduate students like me were convinced of Adam Smith’s “invisible hand”, which guides the markets toward a natural “equilibrium” price, through the interaction of supply and demand. This is the “sweet spot”, the “right price”, the “true value” that any asset or commodity is worth. And when it comes to interest rates, whether it is for municipal bonds, car loans, or mortgages, these are supposed to come to be naturally in the market, through the interaction of supply and demand.
Incidentally, Adam Smith, the “father of modern economics”, who in 1776 wrote the book, “An Inquiry into the Wealth of Nations”, taught the same economics principles about supply and demand, about achieving equilibrium prices. Laissez-faire was a doctrine we were persuaded to believe as business school graduates, a doctrine that opposes governmental interference in economic affairs beyond the minimum necessary to maintaining peace and property rights. Yet today, we have more government intervention in the markets, and through monetary policies of the Federal Reserve Bank, interest rates, the “price of money”, has been the main tool of our federal government, to replace the “free market”, through excessive monetary policy. These actions have created wild swings in interest rates (the price of money). I suppose it is possible our professors taught us wrong, as a joke, but this is what I and all my business school colleagues were taught.
I met with the City Treasurer of my organization this week. He is very involved and diligent in the management and investment of our idle cash balances to maximize interest earnings while preserving the safety-liquidity-yield objectives. He meets quarterly with me and the City Manager to go over the status of investments, providing direction as chief investment officer for our city. With all the uncertainty in the bond markets, and the attractive yields at LAIF (Local Agency Investment Fund) here in California, he is taking a wait and see approach for the next 90 days. The greatest concern we all face in municipal finance is the volatility and uncertainty in the markets, specifically about interest rates. The normative expectations we relied upon during the last 40 years no longer apply. The economic levers in the money market just don’t make sense. Certainly, the financial models we relied upon in the 1980s and 1990s do not seem to work in pricing capital assets anymore.
The components of interest rates include: (a) risk free rate, (b) inflation premium, (c) default risk premium, (d) liquidity premium, and (e) maturity premium. As you study these five components of interest rates, you might well conclude that the “near zero percent” interest rates we “enjoyed” during the 10 years from 2012 – 2022, these did NOT reflect the “real” economic reality of supply and demand on interest rates. The only reason our interest rates hovered under 1% during that magical decade was 100% due to the “easy money” monetary policy of the Federal Reserve Bank. If you were a buyer of US government bonds, which are considered “risk free” investments, you should have at least asked for bond yields (interest rates) high enough to at least cover the inflation and liquidity premium, yet the US Treasury bill was paying you less than 1% (0.74%) in 2020. The inflation rate during 2020-2021 was at 1.5% to as much as 5%. The US government bond interest you earned was not even enough to cover inflation, much less the liquidity or risk-free rate that you should earn as a government bond investor!
With all that said, have you ever noticed how the bond market sometimes feels like it’s playing by its own set of rules? You’d think that when the Federal Reserve cuts interest rates, bond yields would naturally go down, right? That’s the “textbook” version. But lately, reality has been throwing us a curveball — 10-year Treasury yields are still hanging around 4%, even after those rate cuts. If you’re a government worker trying to grow your investments, this isn’t just a quirky market fact. It’s something that could directly impact your financial future. So, let’s pull back the curtain and make sense of what’s really going on. Certainly, if we don’t, the Bond Vigilantes may be there to do this for us!
Please allow me to put in a plug for my municipal services firm for a moment. With decades of experience in municipal staffing and consulting, MuniTemps has been connecting cities with skilled municipal professionals who provide the essential administrative support needed to keep local government running smoothly. And just like we help cities and their employees achieve stability and long-term success in their work, this article will help you, as a local government or other public-sector employee, understand and prepare for the sometimes-puzzling world of bond yields. In fact, what you’ll learn here is key to creating a long-term financial plan that can weather market surprises.
This contradiction isn’t just an academic theory – it directly impacts your financial independence strategy. As a government worker building wealth through TSP and other investments, understanding this bond market behavior becomes crucial to protecting what you’ve worked so hard to accumulate.
The numbers tell a striking story. Early in 2023, 10-year yields peaked near 5% before retreating to 4% – a roller coaster that left many portfolios dizzy. But here’s what should really get your attention: as we move further into 2025, U.S. Treasury yields are surging again, with the 10-year yield approaching 5%. These are levels we haven’t seen consistently since before the 2008 financial crisis.
Are you prepared for what this means to your retirement planning? Your TSP investments don’t exist in a vacuum. When bond markets move against conventional wisdom, they drag other investments along for the ride. The S&P 500, which captures approximately 80% of available market capitalization, often responds to these yield movements – directly affecting your broader investment portfolio.
This apparent contradiction between central bank policy and market reality follows specific patterns. Bond yields sometimes march to their own drummer, regardless of what the Federal Reserve decides. Understanding these forces helps you make smarter decisions about your government benefits and long-term wealth building strategy.
The Bond Market’s Basic Rules That Every Government Worker Should Know
Bond prices and yields move like opposite ends of a seesaw – when one goes up, the other goes down. This fundamental relationship drives much of what happens in the fixed-income markets that affect your investments.
Think of a bond yield as the return you expect to receive, calculated by dividing the bond’s annual interest payment by its current market price. This simple math helps you evaluate whether a bond makes sense compared to other investment options in your portfolio.
Here’s how this plays out in real numbers. A $1,000 bond paying $50 annually gives you a 5% yield. But what happens when interest rates in the broader market rise to 6%? That existing 5% bond suddenly looks less attractive. Its price must fall below face value until its yield becomes competitive with newer bonds offering a higher 6% return.
This explains the connection between central bank actions and bond behavior. When the Fed hikes rates, existing bonds with lower coupon rates must sell at discounts to compete with newer, higher-yielding issues. The opposite also holds true – if rates fall to 4%, that same 5% bond becomes more valuable, pushing its price higher.
The takeaway for your investment strategy? When you hear about bond yields rising, it typically means bond prices are falling as investors demand higher returns. This usually happens in response to changing economic conditions or inflation expectations – factors that can ripple through your entire retirement planning.
Your TSP bond funds follow the same principles. Understanding this seesaw relationship helps you make sense of why your G Fund and F Fund perform differently when interest rates shift.
The Real Forces Behind Rising Bond Yields
Long-term bond yields don’t follow central bank orders – they respond to what economists call the “Fed information effect.” When the Federal Reserve cuts rates, smart money interprets this as a warning signal. If the Fed needs to cut rates, maybe economic fundamentals are weaker than anyone realized. This contrary reaction explains why corporate bonds with higher credit risk significantly underperform following monetary easing.
Let’s face it, inflation expectations drive this seemingly backwards behavior. Inflation acts as a bond’s worst enemy, quietly eroding the purchasing power of every future payment. When investors suspect the central bank has set rates too low, they start expecting future inflation to heat up. This pushes long-term interest rates higher relative to short-term rates – steepening what bond traders call the yield curve.
But there’s more at work here. Term premiums – the extra yield investors demand for holding longer-term debt – fluctuate like a fever chart. These premiums shift based on inflation uncertainty, countercyclical risk aversion, and varying demand for risk-free assets. After the Great Financial Crisis, term premiums have been declining persistently following both tightening and easing shocks.
Central bank credibility matters more than you might think. As the Fed’s credibility increases, macroeconomic variables fluctuate less because private agents’ expectations become more anchored. About two-thirds of the observed decline in the volatility of U.S. long-term rates after the mid-1990s can be attributed to increased Fed credibility.
What does this mean for your TSP and other investments? When bond markets start questioning Fed policy, your balanced funds and G Fund returns feel the impact. Understanding these market psychology patterns helps you anticipate when your government benefits might face headwinds from broader economic forces.
The Hidden Forces That Can Derail Your Retirement Plans
Beyond Federal Reserve decisions, other powerful forces shape the bond market – and they directly threaten your path to financial independence. Government deficit spending creates a flood of new bonds that pushes yields higher regardless of what central bankers want. Currently, the U.S. sovereign debt has reached its highest level ever, exceeding post-WWII records.
When the government borrows massive amounts, it competes with your TSP bond investments for investor dollars. This competition drives up the cost of borrowing across the board. Research shows that fiscal imbalances particularly impact country-specific yield components, especially after sovereign debt exceeds 46% of GDP. Those soaring interest payments crowd out other public expenditure or pressure governments to raise taxes – potentially affecting your future federal benefits.
Geopolitical storms also batter bond markets without warning. Studies indicate that geopolitical risk increases are associated with higher sovereign bond yields, as investors demand additional risk premiums during periods of heightened uncertainty. These shocks don’t just hit bonds – they adversely impact stock markets, corporate investment, and overall economic activity, rippling through your entire TSP portfolio.
Trade tensions create their own market earthquakes. The numbers don’t lie: following tariff announcements in April 2025, the 10-year Treasury yield sold off 49 basis points within a single week. Economic policy uncertainty reached its highest level this century in early 2025, surpassing peaks during the 2008 financial crisis and COVID-19 pandemic.
Even political theater affects your investments. Debt limit confrontations lead investors to demand higher yields due to heightened default possibilities. Remember the 2023 debt limit episode? It triggered a record 5.84% yield on 4-week securities – the highest auction yield since 2000.
Your retirement security depends on understanding these forces. While you control your TSP contributions and federal benefit timing, external pressures like deficit spending and global tensions operate beyond your influence. Building a robust financial foundation becomes even more critical when these unpredictable forces can shake markets at any moment.
Your Path Forward: Making Bond Market Mysteries Work for Your Financial Future
Bond yields don’t follow the simple rules that textbooks teach. This contradiction between central bank actions and market reality isn’t just academic curiosity – it’s financial intelligence that can protect and grow your government worker advantage.
The forces driving this behavior run deeper than Federal Reserve decisions. Inflation expectations drive much of what you see when yields climb despite rate cuts. Market participants smell future inflation that could erode your carefully planned retirement income. Term premiums add another layer, fluctuating based on economic uncertainty and investor appetite for risk.
Financial realities matter too. Government deficits require massive bond issuance that floods the market with supply, pushing yields higher regardless of what the Fed does. Geopolitical tensions and trade disputes pile on additional risk premiums that bond investors demand as protection.
Remember that your government position gives you tools most investors don’t have. Your FERS system provides stability to weather these bond market storms. Your TSP contributions continue building wealth even when yields behave unexpectedly. This knowledge doesn’t just explain market movements – it helps you make smarter decisions about timing your retirement and protecting what you’ve built.
Bond yields represent more than simple reactions to central bank decisions. They reflect complex economic expectations, fiscal pressures, and global uncertainties that shape your financial landscape. When conventional wisdom fails, understanding these deeper patterns keeps your financial independence strategy on track.
The road to financial freedom requires patience and knowledge. Bond market mysteries become less mysterious when you understand the forces at work. Your government benefits remain your foundation – use this market intelligence to build an even stronger financial future on top of that solid ground.
Together with the important points we’ve covered in this article, John Herrera, CPA, encourages all government employees to set clear, long-term financial goals. Understanding how and why bond yields behave the way they do gives you the knowledge to protect your retirement plan and make smarter investment decisions.
Contact our team at jobs@munitemps.com or visit www.munitemps.com to learn more about how we support municipal careers. At MuniTemps, we’re experts in all things municipal — from staffing and recruiting to creating career opportunities for job seekers passionate about public service in local government.
Be sure to visit the MuniTemps CitySpeak YouTube channel and check out the video blogs from five years ago that highlight a conservative, common-sense approach to long-term financial planning. You may find concepts or tools that you can apply throughout your career in municipal or other government service. You might also want to watch the video titled “What Recession Feels Like at City Hall.” which offers practical tips for navigating economic downturns in the public sector.
Thank you for joining us today. Here’s to building a stronger financial future!