(Updates with New Jersey, New York sales in fourth paragraph.)

Dec. 6 (Bloomberg) -- Municipal bonds rallied, pushing 10- year yields to the lowest since September, as investors put to work the largest amount of coupon payments and principal redemptions in five months.

The yield on benchmark 10-year U.S. tax-exempt bonds fell to 2.1 percent at 4 p.m. in New York from 2.18 yesterday, according to a Bloomberg Valuation Index. That’s the lowest level since 2.07 percent on Sept. 28. The closing yield of about 2 percent on Sept. 23 was the lowest since the index began in January 2009.

“There’s bonds coming out of the market through coupon payments for Dec. 1 and Dec. 15 and there’s not that many bonds being created,” said Hardy Manges, head of municipal trading at Mitsubishi UFJ Securities in New York, in a telephone interview.

In sales today, New Jersey issued $2.15 billion of debt due in June, and New York sold $330 million of bonds with maturities as long as December 2041, according to data compiled by Bloomberg. The amount of local-government debt scheduled for sale in the next 30 days is down 42 percent from an 11-month high of $14.4 billion on Nov. 15, according to data compiled by Bloomberg.

December Payments

Payments from coupons and principal are set to tally $36 billion this month, the most since close to $41 billion in July and up from $24 billion in November, said Chris Mauro, head of U.S. municipal strategy at RBC Capital Markets in New York.

The rally comes as Richard Lehmann, publisher of the Distressed Debt Securities Newsletter, said municipal-bond defaults will reach $20 billion this year when including AMR Corp.’s bankruptcy and tobacco bonds. That would exceed the previous high of $8.62 billion in 2009, his data show.

New Jersey’s sale, with the highest short-term debt rating from Moody’s Investors Service, attracted $14.9 billion of bids, according to Andy Pratt, a spokesman for Andrew Sidamon- Eristoff, the state treasurer.

New York, with an Aa2 grade, Moody’s third-highest, sold both tax-free and tax-exempt debt.

--With assistance from Michelle Kaske in New York and Elise Young in Trenton, New Jersey. Editors: Mark Tannenbaum, Ted Bunker

To contact the reporter on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net