Normally, municipal bonds (which pay tax-exempt interest) have lower yields than Treasury bonds (which pay taxable interest). Today, though, high-quality municipal bonds yield more than Treasuries of comparable duration. As of this writing for example, the 10-year Treasury was yielding 2.98 percent, according to Bloomberg.com, and 10-year, AAA-rated, general obligation (GO) muni bonds yielded 3.19 percent.
There are two primary reasons why munis yield more than Treasuries now:
1. Last year’s financial crisis drove many investors to the safety of Treasuries. With demand up for Treasuries, demand is down for munis. Therefore, municipal bond prices have dropped and their yields have increased.
2. Some investors fear that municipal bond issuers such as state and local governments would suffer from falling revenues because of spreading economic weakness. Again, weak demand has caused muni prices to fall, increasing yields.
In reality, state and local finances are in decent shape, overall. Thus, the risks of default are modest and the high tax-exempt yields are appealing.