Municipal bond prices rallied this week on growing demand and solid results in the Treasury's refunding auctions, pushing The Bond Buyer's indexes lower in yield for the second straight week.

The 20-bond index of general obligation bonds fell 13 basis points, to 6.38% from 6.51% from a week ago. The 11-bond index declined 14 basis points, to 6.28% from 6.42%

The Bond Buyer altered the composition of the 20-bond and 11-bond indexes by replacing Illinois with South Carolina. The revision was done to offset the effect of recent downgradings on the two indexes' average ratings of Al for the 20-bond index and Aa for the 11-bond index.

The 30-year revenue bond index was off 13 basis points, to 6.57% from 6.70% last week.

The municipal bond index's average yield to maturity dropped nine basis points, to 6.46% from 6.55% last Thursday.

The three weekly indexes have fallen 24 to 25 basis points in the past two weeks and are at their lowest levels since Oct. 15, when the 20-bond was 6.34%, the 11-bond was 6.25%, and the revenue bond was 6.51%. The daily index's yield to maturity has fallen 35 basis points from its most recent high of 6.71% on Oct. 28, and is at its lowest level since Oct. 16, when it was also 6.46%.

U.S. Treasury debt prices rallied during the week, but still underperformed municipals. The bellwether 30-year Treasury bond's yield fell nine basis points, to 7.59% from 7.68%.

While the supply of new municipal bonds continued to drop from previous heavy levels, the demand for tax-exempts started to rise, boosted by the success of the Treasury's $60 billion in debt auctions this week and by expectations that upper-income tax brackets will be raised.

"Right now we're in a rally that is spurred by the Treasury market's ability to digest its refundings with no problem," a bond analyst said. "Municipals moved ahead of Treasuries last week and are moving with governments now. Treasuries have gotten over their supply hump and are trading to a median price. In addition, a very thin municipal calendar is driving prices higher."

A bond researcher said, "The municipal market has become exceedingly cheap due to the thin new-issue calendar, and it's rallied off those levels."

The Bond Buyer's 30-day visible supply was $6.58 billion yesterday, off $520 million from last Friday's $7.1 billion.

"We've gotten back most of what was lost in October," said Robert Chamberlin, senior vice president of municipal research and marketing at Dean Witter Reynolds Inc. Between Sept. 24 and Oct.29, the 20-bond index rose 29 basis points, the 11-bond index gained 30 points, and the revenue bond climbed 32 points.

The decline in yields is "an indication of what happens when you have two weeks of minimal new-issue volume," Chamberlin said. "In addition, you've had a heavy drawdown on inventories, as evidenced by [Standard & Poor's Corp.'s] The Blue List"

As of yesterday, The Blue List totaled $954 million , down $196 million from last Friday's $1.15 billion and at its lowest level since July 31, when it was $940 million.

"We've also had soothing conversation from President-elect Clinton" in regard to his economic stimulus program, which has abated the municipal market's fear of a surge in inflation, Chamberlin said.

The markets have also rallied on "expectations of tax hikes on upper incomes, which has brought money into muni funds," the bond researcher said.

The short-term market moved in the opposite direction of long-terms, as The Bond Buyer's one-year note index rose seven basis points, to 2.98% from 2.91% a week ago.

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