U.S. municipal bonds may outperform Treasurys as investors pour money into tax-exempt bonds and local governments sell fewer fixed-rate...

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U.S. municipal bonds may outperform Treasurys as investors pour money into tax-exempt bonds and local governments sell fewer fixed-rate securities than they did last year, according to analysts at Merrill Lynch.

The yield on top-rated, tax-exempt bonds with longer maturities dropped below similarly dated U.S. Treasury debt, showing the “renormalization” of the relationship between the two securities, Merrill analysts said in a report last week.

Usually, municipal bonds yield less than Treasurys because investors don’t have to pay income taxes on their returns.

The yield of municipal bonds compared with Treasurys, known as the muni ratio, held above 100 percent for much of this year as the fallout from the credit crisis on Wall Street caused banks and investors to sell bonds backed by insurance companies that are struggling to protect their credit ratings.

“We expect further declines in muni ratios, as the sale of fixed-rate issues is relatively light and demand remains solid,” Merrill Lynch said.

State and local government bonds have delivered better returns this month than either Treasurys or corporate bonds.