Analysts are scratching their heads.

“It’s hard to believe that three months ago we looked upon the bond funds world with amazement because the average taxable bond fund was up 5.32 percent for the second quarter. We had to go back to Q2 1995 (+5.56 percent) to find a better quarter,” says Jeff Tjornehoj, a research manager for the United States and Canada with Lipper in Denver. “Considering those are the kinds of numbers we’re used to seeing over a full year, it was natural to expect the bond market to take a breather.”

But the bond rally went beyond most expectations, Tjornehoj notes, most notably in the muni-bond arena. High-yield municipal debt funds rocketed to the top of the quarterly performance tables with returns of 14.07 percent for the third quarter.

Treasury-related Lipper fund classifications were led by general U.S. Treasury funds (+4.74 percent) as strong bidding for Treasury paper boosted returns, including a rise of 2.04 percent in September.

Meanwhile, TIPS Funds gained 3.52 percent for the quarter (and 2.03 percent for September) as investors sensed that the massive debt issued by Uncle Sam would likely ignite inflation down the road. The U.S. government will have issued nearly $7 trillion in debt by the time the current fiscal year ends, though CPI numbers haven’t pointed to inflation directly.

Corporate debt staged another unbelievable rally in the third quarter, sending high-yield funds up 13.05 percent. Corporate debt A-rated funds (+6.59 percent) also had a stellar quarter, but the group was strongly outperformed by the lower BBB-rated corporate debt funds (+8.98 percent). Much, if not all, of this rally was due to narrowing yield spreads, according to Lipper, which were substantially better farther down the quality scale.

Investors sought out riskier assets in the third quarter and that pushed emerging-market debt funds (+11.38 percent) well ahead of their higher-quality peers. And international income funds were up 8.26 percent in the last three months.

In addition, muni-debt funds staged a spectacular rally, climbing an average of 7.75 percent in the quarter. Much credit for this goes to the Build America Bonds program. For example, the yield on California’s 30-year Build America Bonds was 6.69 percent at the end of September, down from 7.43 percent when they were sold in April.