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When interest rates move, either higher or lower, the effect is felt quickly throughout the economy, affecting mortgage rates and housing demand, changing the cost of products we buy, and causing shifts in consumer confidence.

But the most significant impact of higher interest rates is on our annual federal budget deficit. The U.S. national debt — the sum total of all our accumulated budget deficits — stands at roughly $36 trillion! And we are adding to that sum with annual budget deficits of around $2 trillion.

We finance that debt by selling Treasury bills, notes and bonds (shorter to longer maturities) at huge weekly and monthly auctions. Those auctions raise money to repay maturing debt, and to borrow the extra money to pay for current deficits.

The interest rates on those debt sales are set by bidders, including foreign central banks, global sovereign wealth funds, global banks, money market funds and other institutional investors who decide, based on the outlook for inflation and other factors, what interest rate they will accept.

Ordinary investors like you and me can participate in these weekly T-bill sales with a minimum of only $100. But we don’t “set” the rates; instead, we agree to “accept” the rates set at auction by the big world players. (See “How to Buy T-bills” at TerrySavage.com, which explainshow individuals can participate in these auctions through their online TreasuryDirect.gov accounts.)

The smart global money evaluates the rates it will accept based on its willingness to invest in America’s debt. Currently, foreign investors own more than $7 trillion of our debt, with leading central banks in China and Japan among the largest holders at just under $1 trillion each.

If the big buyers are less willing to hold our debt, they will demand higher interest rates. Recent concerns over U.S. trade policy have definitely pushed rates slightly higher at the weekly and monthly auctions.

On the other hand, fears of a recession caused by tariffs have tended to work in the opposite direction, pushing rates down. During a recession, borrowing demand slows from businesses and individuals. Even so, if a recession lowers tax revenues and increases government borrowings, rates could eventually move even higher!

Currently, interest on the national debt costs roughly $1 trillion per year. And it’s estimated that a one percentage point increase in interest rates at the auctions could add $187 billion a year to our deficits. (Think of it as the interest on interest that you pay on your credit card, building up the balance amount you owe!)

Given all of the headlines about the Federal Reserve, you might think it totally controls interest rates with its decisions to raise or lower short-term rates. The Fed does have an impact — but mostly on short-term rates. It sets the rates for the huge inter-bank overnight borrowing rates.

Those Fed rate decisions spread throughout the economy quickly. Higher rates can trigger tighter credit and borrowing conditions, slowing the economy. And the reverse is also true; lower rates stimulate the economy.

The Fed also has an impact on the supply of money moving throughout the economy. When it pulls liquidity out of the market, the economy slows. In this way, it tries to balance economic growth and employment while controlling inflation expectations.

But the Fed’s control over longer-term rates is far less direct. As noted above, those rates are set in the Treasury’s auctions — and depend on the direction set by global bond buyers. And since all of those outstanding bonds trade on a daily basis, with market rates changing constantly, you can follow current yields for all Treasuries (and other global bond rates) at CNBC.com under the “Bonds” tab on the home page.

Here’s a critical point for every bond investor to know: When interest rates rise, bond prices fall.

That means you can actually lose money in bonds — even the safest U.S government bonds. Suppose you purchase a 10-year Treasury bond (not a savings bond) with a coupon rate of 3.5%. You know you will get your $1,000 face value back in 10 years when the bond matures, and will certainly be paid that fixed rate of interest every six months.

But if interest rates rise in the bond market, and the Treasury must pay 4% to get buyers to purchase the next sale of 10-year Treasuries, then the current market value of your 3.5% bond will fall. That is, if you need to sell the bond at that point, you will receive less than $1,000 per bond.

The amount of the price decline depends on the maturity of your bond — the length of time your money is tied up. This has nothing to do with credit quality and everything to do with market prices. And it is the reason that your safe bond portfolio could show a decline in market value when you look at your account statement.

Just like stocks fluctuate, bond prices can also go up and down, impacting your diversified retirement portfolio. Only the shortest-term IOUs are exempt from fluctuating bond prices, since they are liquid assets. That’s the true definition of “chicken money” investments: no price fluctuation. And that’s The Savage Truth!

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(Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” Terry responds to questions on her blog at TerrySavage.com.)

©2025 Terry Savage. Distributed by Tribune Content Agency, LLC.