Municipal bond prices dropped sharply Wednesday and yesterday at the prospect of higher interest rates, wiping out a four-day rally and leaving yields on The Bond Buyer's indexes roughly unchanged on the week.

The 20-bond index of general obligation yields was unchanged from a week ago at 6.22%. The 11-bond index slipped one basis point, to 6.13% from 6.14% last Thursday.

The revenue bond index also was off one basis point, to 6.46% from 6.47% a week earlier.

The average yield to maturity of the 40 bonds used in the daily Municipal Bond Index, most of which are revenue bonds, declined five basis points, to 6.39% yesterday from 6.44% the previous Thursday.

Municipal prices did slightly better than U.S. government securities, as the Treasury's bellwether 30-year bond rose two basis points in yield, to 7.54% yesterday from 7.52% a week earlier.

"The real catalyst for the bond market was [Federal' Reserve chairman Alan] Greenspan's Humphrey-Hawkins testimony," a bond market analyst said, "Everyone was positioned for Greenspan to announce Fed complacency on rates, but his views came out rather hawkish. He seemed to be laying the groundwork for a tighter policy, not necessarily right away, but somewhere down the road."

In his testimony before Congress Wednesday, Greenspan said that inflation worries have surfaced in the commodity and financial markets, including the foreign exchange market. "An increase in inflation would come at considerable cost," Greenspan said. He also warned of signs of wage pressures in the labor markets. "[Greenspan] emphasized the weaker dollar in his testimony," the analyst continued, "which would indicate the Fed will defend the dollar, bringing implications of higher interest rates."

Some municipal market players took a pessimistic view of Greenspan's comments, with predictions of an 8% long bond by summer's end.

"I don't think we're going to snap back from this," a municipal market player said. "The Treasury market takes on big supply next month, and the boys are pretty negative right now."

Next week the Treasury will auction $28 billion of two-year and five-year notes.

"We had a brief respite from our inexorable trek downward, but that window of opportunity appears to be firmly shut," a bond trader said.

A favorable jobless claims report yesterday morning helped the market claw back to firm ground. Initial claims for state unemployment insurance rose 27,000 in the week ended July 16, the Labor Department said. Claims hit a six-month high in the latest report, and the number was well above analysts' expectations, bolstering beliefs of a slowing economy.

However, the Philadelphia Federal Reserve Bank's business outlook survey, released later in the morning, indicated substantial upward price pressures in the manufacturing sector over the next six months, throwing the markets back into neutral.

"It's back into the foxhole again," a broker said. "The broker bid-wanted is heavy here, but nothing is trading. Nobody wants to throw a bid out there."

The Bond Buyer's one-year note index jumped 15 basis points on Wednesday to 4.15%, the highest level since Dec. 4, 1991, when it was 4.18%.

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