Tax-exempts continued their quiet rally for a third day Friday, guided by a strengthening Treasury market initiated by the slimmest nonfarm payrolls gain in 2011.

“It’s been a steady grind higher with people wondering what they are going to do for munis in the coming weeks,” a trader in San Francisco said, referring to the light supply.

Tax-exempt yields were flat to two basis points firmer Friday, according to Municipal Market Data’s triple-A scale.

Modest gains in the week pushed the 30-year muni yield to a fresh calendar-year low of 4.25%. The benchmark 10-year yield fell five basis points in the week to 2.60%, just one basis point from its 2011 low in mid-May. The two-year yield held at 0.44%, also a calendar-year low.

The 10-year Treasury yield fell as low as 2.95% after it was reported the economy added just 54,000 jobs to the economy in May, versus 232,000 in the previous month. Its yield finished the day where it started, at 3.02%.

MMD’s Randy Smolik noted the taxable market appeared indecisive as weak U.S. data contrasted with upbeat news that European sovereign-debt issues could find near-term resolution.

The volatile trading, coupled with broad losses in the equity market, kept muni trading limited on Friday.

This week should provide better pricing guidance, as new supply is anticipated to jump to $4.68 billion from $2.3 billion last week, according to Ipreo and The Bond Buyer.

Traders say new-issue pricing should remain firm to strong as the market enters the summer reinvestment period, but secondary trading could be light as retail demand continues to wane owing to low nominal yields.

“Retail demand is falling off — they just aren’t excited with where yields are at,” the San Francisco trader said.

The iShares S&P National AMT-Free Bond Fund, a $2.1 billion exchange-traded fund, rose 0.13% Friday and 0.83% for the week, ending at $103.90.

But not all is well in Muniland. Outflows among municipal mutual funds continued for the 29th consecutive week in the period ending June 1. The Lipper FMI data showed net outpourings of $436 million from muni funds that report their flows weekly, versus $296 million in the week before.

Even high-yield bonds saw outflows of $44 million, breaking a three-week trend propelled by crossover buyers anticipating credit spreads to tighten.

When weekly outflows fell to just $95 million three week ago, there was widespread speculation that funds would begin to see inflows and provide support for the muni market.

“Over the last few weeks however, outflows have been slowly increasing,” noted Chris Mauro, director of muni research at RBC Capital Markets. He estimated that total outflows since November now total close to $50 billion.

The San Francisco trader said the outflows have, at least, created opportunities in the marketplace that would otherwise be absent considering how light issuance has been.

“The best thing that ever happened to the muni bond market was for Meredith Whitney to come out with what she said,” the trader added, referring to the Wall Street analyst’s predictions of massive muni defaults. “It created opportunities to buy in the market place. Without that outflow from mutual funds, the market would have completely seized up without any new-issue supply.”

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