Are credit markets returning to "normal"?

[baw703916]

I just noticed something interesting. At the long end of the yield curve (≥ 5 years), Treasuries are yielding considerably more than munis. At 10 years, (per Bloomberg) Treasuries have a yield of 1.98%, compared to 1.70% for munis (Bloomberg doesn't specify exactly which munis, but they used to quote the rates on AAA general obligation bonds).

OK, that doesn't sound surprising: after all the munis are tax-exempt. But more or less continuously since mid 2007 (right when the financial crisis was starting to unfold), munis have had higher yields than Treasuries. (Which is why I spent quite a bit of time arguing that the conventional wisdom of stocks in taxable, bonds in tax-advantaged isn't always correct--one needs to look at the rates). Maybe things are now returning to normal?

This isn't the case (yet, anyway) at the short end. Two year munis have higher yields than 2 year Treasuries. Larry Swedroe has remarked on several threads that munis generally have a steeper yield curve (and therefore it may be worth taking more duration risk on TE bonds). Currently, it's the opposite--maybe rates on short-term Treasuries are still artificially depressed?

[Valuethinker]

There is no right or wrong of this, but a couple of observations:

- US Treasury bonds are the world's safe US dollar global asset, therefore driven at the margin by global investors, and by expectations of currency as well as interest rates

- US municipals are an essentially US domestic market, therefore they can uncouple from broader trends-- US tax rules have a lot to do with them

-California is instructive. 4 years ago, the state looked bust. Now careening towards a surplus. What is happening is a bifurcation (or a multifurcation) between the likes of Harrisburg PA (terminally bust) and state and local governments who with economic recovery, are starting to look a whole lot healthier

And so what I suspect is some combination of great optimism about US recovery (and hence US dollar assets) and greater domestic optimism in the US re fiscal problems at state and local level.