Munis Extend Best Rally in 20 Months on Fed as Supply Drops

The U.S. municipal market is heading for its biggest monthly rally since January 2012 as dwindling supply helps extend gains following the Federal Reserve’s decision to continue the pace of its bond buying.

The $3.7 trillion market gained 2.1 percent this month through Sept. 23, Bank of America Merrill Lynch data show. Yields on benchmark munis maturing in 10 years fell about 0.1 percentage point to 2.71 percent, the lowest since June 21, data compiled by Bloomberg show. It was the biggest drop in almost three months.

Localities from Connecticut to California are set to sell $4.1 billion in long-term debt this week, the least for a non-holiday period since Aug. 16, Bloomberg data show. Fed Chairman Ben S. Bernanke unexpectedly refrained from curbing the central bank’s monthly bond purchases in a meeting last week.

“The Fed saying that the economy was too weak for them to tighten was very bond-supportive,” said David Frank, managing director of muni trading at CastleOak Securities LP in New York. “Crossover buyers took a lot of supply out of the market, and now lack of supply is extending the rally.”

Even though individuals have yanked money from muni mutual funds for 17 consecutive weeks, in the seven days through Sept. 18 they pulled just $1.1 billion, the smallest withdrawal since Aug. 7, Lipper US Fund Flows data show.

The $3.1 billion iShares National AMT-Free Muni Bond ETF, known as MUB, rose 29 cents to $104.28, the highest since July 19.

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