NEWYORK
Yields on U.S. government debt briefly crossed 5 percent, a level not seen in years, as the bond market reprices the rising cost of federal interest expense and fiscal strain.
The move reflects institutional money's calculation that higher yields reduce the penalty for misjudging rate direction. Michael Reynolds, vice president of investment strategy at Glenmede, said that a buy-and-hold investor holding a 4.90 percent bond with 5.8 years duration can absorb an 84-basis-point yield increase before mark-to-market losses erase one year of interest income.
Reynolds said Glenmede sees greater opportunity in longer-duration positions now. "As rates rise, the cost of being wrong about direction decreases," he said. "That's a key consideration for total return math that factors in both price changes and interest income."
Higher yields ripple through the economy. Consumers and businesses face higher loan rates, while the federal government's debt service burden climbs as the national debt grows faster than tax revenue.
For municipal borrowers, rising yields also affect private activity bond issuance costs. Internal Revenue Code Section 147(g) caps issuance costs financed by a private activity bond issue at 2 percent of proceeds—or 3.5 percent for qualified mortgage bonds and qualified veterans' mortgage bonds with proceeds of $20 million or less. Any costs exceeding these thresholds must be covered by the issuer's own funds or other taxable loans.
The restriction applies only to the federal subsidy for such financing, not the financing itself. The costs—underwriters' spreads, counsel fees, rating agency fees, printing and engineering costs—can come from the 5 percent or less of bond proceeds not used for the exempt purpose of the borrowing, per Senate Committee Report 100-445 from the Technical and Miscellaneous Revenue Act of 1988.
Before Aug. 15, 1986, when the Tax Reform Act of 1986 took effect, no comprehensive cap existed on issuance costs.
