The disappointing Treasury refunding finale put an abrupt end to yesterday's municipal rally.

But the tone remained firm and traders still reported gains of 1/8 to 1/4 point by session's end.

The credit markets got off to a strong start for the fourth consecutive session, this time on news that inflation remained low.

Municipal prices jumped 1/4 to 1/2 point after the producer price index for finished goods declined 0.2% in July on the third monthly fall in food and energy prices. The core rate of inflation, excluding food and energy, inched up 0.1% during July. That index, while less volatile than overall wholesale prices, has risen at a slightly higher rate in the last year of 1.7%.

Traders reported brisk secondary activity as bullish market players sold bond to permanent investors and yields continued to decline, hitting record lows.

"People are saying it's getting too emotional and we're seeing some bid-wanted, but I think that just helps us out," said one bullish trader at mid-morning.

The 30-year Treasury bond hit a record low of 6.37% by mid-morning and the tone was strong enough for the Street to disregard lower jobless claims and slightly stronger retail sales numbers.

Initial state unemployment insurance claims fell 3,000 to a seasonally adjusted 332,000 in the week ended Aug. 7, while auto sales tumbled, slowing retail sales, which inched up only 0.1% in July to $172.3 billion.

But governments were yanked back when the last leg of the Treasury refunding showed poor coverage. Treasuries sold off their gains and the long bond snapped back to 6.43% in late action.

The fall in governments took the wind out of the municipal surge, but bonds were still quoted higher on the day at the close.

For example, Charlotte Convention Center COP AMBAC 5 1/4s of 2020 were quoted late yesterday at 5.51% bid, compared to 5.55% Wednesday.

In the debt futures market, the September municipal contract hit a high of 104.06 and sank back to a low of 103.07, before setting down 4/32 to 103.13.

The MOB spread narrowed to negative 402 from negative 407 Wednesday, as municipals continued to outpace the Treasury market. Lehman Brothers underwriters took down the biggest competitive deal yesterday and reported good demand from investors, reflecting broad-based strength in the marketplace.

Lehman won $175 million of Florida Board of Education public education capital outlay refunding bonds with a true interest cost of 5.2756%.

The firm reported all bonds sold and one underwriter said said all but $4 million of the deal was done pre-sale.

"Demand was excellent," he said. "It seems like there is too much cash chasing too few bonds."

Donaldson, Lufkin & Jenrette Securities Corp. had the cover bid with a TIC of 5.3078%.

Serial bonds were reoffered to investors at yields ranging from 3.30% in 1995 to 5.35% in 2014. A 2017 term, containing $25 million, was priced as 5 1/4 to yield 5.375%.

The offering is rated Aa by Moody's Investors Service.

Yesterday's abbreviated rally had little effect on the overall down trend of rates.

The Bond Buyer's daily Municipal Bond Index rose to another record high, reaching 103.12 to yield 5.64% to maturity. The index began on July 2, 1984.

The 30-year old Revenue Bond Index, which began in September 1979, fell to a record low 5.68%.

The 20-bond index of general obligation yields fell to 5.45%, it's lowest level since Nov. 23, 1977, when it also was 5.45%. The 11-bond GO index dropped to 5.36%, the lowest it has been since March 23, 1978, when it was 5.34%.

Traders said late in the day that, with the refunding out of the way, technicals would rule the market over the near term. So far, that means good news for municipal bond prices.

Dealers have been able to sell off significant inventory during the rally and upcoming supply has remained low.

That could soon change, as one trader noted. "Greed and fear run Wall Street; if there are deals to do, they'll bring them," he said, adding that for now, demand outweighs supply.

Reflecting that notion, The Blue List fell for the fifth consecutive day yesterday, to $1.27 billion, its lowest level since May 10 when it was $1.19 billion. Since Aug. 4, when the list began to decline, it has plunged $700 million, or about 36%.

The last time The Blue List spent three straight days under $1.5 billion was the May 4 through May 17 period, when it was between $1.19 billion and $1.46 billion.

Meanwhile, the 30-day visible supply as calculated by The Bond Buyer is down $995 million, to $3.602 billion, its lowest level since June 30 when it was $3.569 billion.

The last time the 30-day visible spent three straight days under $5 billion was Feb. 9 through Feb 19, when it stayed between $3.28 billion and $4.8 billion.

Looking to the economy, some market observers have warned that the market will get caught offsides by greater than expected economic strength.

But, Robert Giordano, a chief economist at Goldman, Sachs & Co., yesterday said that any strength in the economy pales in comparison to its overall weakness.

"If you're assuming strength, it is surprisingly soft," Giordano said. "I do think people have been bullish on bonds overall. The market has been fighting these rates for the last 150 basis points. I think people will be surprised by how soft the economy is and how true rates really are."

New Deals

In the negotiated sector, Kemper Securities Inc. priced and repriced $119 million Indiana Bond Bank common school fund advancement purchase funding bonds.

Yields were raised by 10 basis in 1996 and 1998 and by five basis points throughout the rest of the loan.

The final offering included serial bonds priced at par to yield from 2.80% in 1994 to 5.40% in 2008. A 2011 term was priced at par to yield 5.50%

The issue is insured by the AMBAC Indemnity Corp. and rated triple-A by Moody's and Standard & Poor's Corp.

In other action, Merrill Lynch & Co. tentatively priced $120 million of Bristol, Tenn., Health and Education Facilities revenue refunding bonds for the Bristol Memorial Hospital.

The offering included serial bonds priced to yield from 2.80% in 1994 to 5.30% in 2007. A 2010 term was priced as 6 3/4 to yield 5.42%, a 2013 term was priced as 5 1/4 to yield 5.53%, and a 2021 term, containing $55 million was priced as 5 1/4 to yield 5.63%.

The bonds are FGIC-insured and triple-A rated by Moody's, Standard & Poor's, and Fitch Investors Service.

Executive Life

A California judge is expected to issue a ruling today on a modified rehabilitation plan for the failed Executive Life Insurance Co.

Los Angeles County Superior Court Judge Kurt Lewin is expected to approve the plan. At a status conference yesterday, Lewin said he plans to issue his opinion this week, according to a source who attended the hearing.

Lawyers for trustees and underwriters of about $1.6 billion of taxable municipal bonds have opposed the modified plan, charging it still discriminates against their clients. The taxable bonds are backed by Executive Life guaranteed investment contracts, and those bondholders are the last group opposing the rehabilitation plan.

An initial plan approved by Lewin a year a go was rejected in March by a state appellate court. The modified plan was designed to address the appellate court's concerns, including eliminating a system that would have valued taxable municipal bonds at the price paid, rather than the par value, for establishing recovery levels in a rehabilitated company.

Once Lewin rules on the modified plan, it will return to the appellate level for review.

California Insurance Commissioner John Garamendi devised the rehabilitation plan. Lewin yesterday also granted a request by Garamendi's lawyers to pave the way for liquidating junk bonds remaining in Executive Life's asset base.

Secondary Markets

Traders reported brisk activity until the Treasury market lost ground. Of note, they said there has been more Massachusetts paper out for the bid, in anticipation of next week's $600 million deal.

In late secondary dollar bond trading, prices rose 3/8 point overall, before the fall and ended mixed on the day, traders said.

Philadelphia Water MBIA 5 1/4S were quoted at 5.56% bid, 5.55% offered; PICA MBIA 5.60% of 2015 were quoted at 99 3/4-100 1/4 to yield 5.61% and Fulton-Dekalb County Hospital Authority MBIA 5 1/2S of 2020 were quoted at 5.62% bid, 5.60% offered.

In the short-term note sector, traders said yields were unchanged to five basis points lower on the day.

In late action, California Rans were quoted at 2.95% bid, 2.90% offered and New York State notes were quoted at 5.58% bid, 5.55% offered.

Dennis Walters contributed to this column.

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