Municipals paused early yesterday, but then drove higher for the third straight session, pushing The Bond Buyer's daily Municipal Bond Index to a record high.

Prices opened unchanged to 1/8 point lower after the Treasury market sold off along the yield curve ahead of a 10-year note auction.

The government market is in the process of absorbing $38.5 billion of new debt from the quarterly refunding. Market players were hesitant to resume a rally that began Monday before the results of the note sale were clear.

But tax-exempt traders pulled out the stops after governments rebounded after the sale went better than expected.

The 30-year bond hit a record low of 6.42% by mid-afternoon, while the daily Municipal Bond Index closed at a record high 103.09 to yield 5.65%. That broke the previous record of 103.08 set on March 4.

Traders who reported only spotty "situation" trading during the morning said business flow churned after the Treasury auction as demand for bonds continued to outweigh supply.

"It got frothy if you owned bonds," a trader said. "It could stay this way for a couple of days until the bankers get on the phone to issuers and bring the calendar back."

By session's end, prices were quoted up 1/2 point.

In the debt futures market, the September municipal contract settled up 14/32 to 103.17. The MOB spread narrowed to negative 407 from negative 416 Tuesday as tax-exempts pushed passed Treasuries.

Secondary cash traders said action was especially brisk in New York State Dormitory Authority bonds. Financial Guaranty Insurance Co. was said to free capacity for the bonds. A trader said size blocks in 2019 changed hands at mid-afternoon at 5.69%, up 3/8 point on the day. Another trader said he traded the same bonds at a 5.68% near the close of trading. Bonds due in 2013 were said to trade at 5.68%.

Reflecting the increased investor demand this week, The Blue List fell $103.2 million yesterday, to $1.38 billion, the lowest level since May 14's $1.36 billion. The Blue List has declined $509 million over the past five business days.

Looking ahead to supply, the 30-day visible supply fell $368 million yesterday, to $4.6 billion from $4.96 billion Tuesday. That marked the third straight decline in 30-day supply, which is down $1.85 billion since last Friday.

Although the total visible supply has been lower as recently as July 29, the negotiated component, at $3.42 billion, has not been lower since July 7 when it was $2.99 billion.

Taxes Drive Investors

The bid for municipals has improved markedly this week as investors seek shelter from President Clinton's new tax hikes.

Tax-exempt prices first called just after President Clinton was elected, partly because investors expected the tax hikes.

Traders acknowledged yesterday that the notion of higher taxes is an old one, but they added that the actual passage of the budget has prompted another influx of investor cash.

"The reality of higher taxes hasn't hit home for some people until now," a trader said. "The market is getting a lot of good press and people realize munis are the only place to be right now."

But some market players said the wide-spread notion that the President's tax hike will damage an economic recovery is unrealistic.

"We're still bullish on rates in general because the economy still isn't doing well," said George D. Friedlander, managing director of Smith Barney Shearson's fixed-income high net worth portfolio strategy department. "But it's hard to make the case the tax bill will be a big drag on the economy."

"It's hard to be a bear here, but the idea that the tax bill is going to be very bearish for the economy is a fragile scenario," one trader said. "If the economy starts to pick up we should immediately see rates begin to rise."

James L. Kochan, head of fixed-income research at Robert W. Baird & Co., said yesterday the market could get its first taste of an improving economy in October or even earlier.

"The biggest pitfall ahead is that the market has underestimated the strength of the domestic economy," he said. "The second quarter gross national product numbers showed growth in consumer spending, and we're going to see more."

Kochan said that stronger data on retail sales, housing, industrial production, business inventories all have the potential to catch the market by surprise.

"People are too optimistic," Kochan said. "People are arguing about whether the long bond will go below 6.25%, but I bet we don't go much lower than where we are now.

"You really have to get good news to sustain the current levels and any data that is less than enthusiastic could really catch the market offsides," he said.

New Deals

Topping negotiated action, a 13-member syndicate led by M.R. Beal & Co. tentatively priced $282 million Wisconsin general obligation refunding bonds.

The deal was made up of serial bonds only, priced to yield from 3.30% in 1995 to 5.40% in 2012. The bonds are rated double-A by Moody's Investors Service and Standard & Poor's Corp.

Smith Barney Shearson priced $149 million revenue refunding bonds for the Colorado River Municipal Water District.

The firm said it received the verbal award at the original price levels.

The offering included serials priced to yield from 2.75% in 1994 to 5.50% in 2010. A 2013 term was priced as 5 3/8s to yield 5.55% and a 2021 term, containing $60 million, was priced as 5.15s to yield 5.58%.

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

Goldman, Sachs & Co. as senior manager priced, repriced and restructured $100 million South Broward Hospital District Fla., hospital revenue and refunding bonds.

At the repricing, Goldman lowered serial bond yields by five basis points and three basis points on bonds in 2008 and 2013. A 2007 serial maturity was eliminated and a 2022 term replaced a 2023 maturity.

The final scale included serial bonds priced to yield from 2.80% in 1994 to 5.25% in 2006. A 2008 maturity was priced with a 7.50% coupon to yield 5.375%; a 2013 term maturity, containing $23 million, was priced as 5 3/8 to yield 5.521%; a 2022 term was priced as 5 1/2s to yield 5.60%; and a 2028 term was priced as 5 1/2s to yield 5.70%.

The bonds are AMBAC-insured and rated triple-A by Moody's and Standard & Poor's.

In light competitive action, $136 million Clark County, Nev., School District limited tax general obligation bonds were won by a Merrill Lynch & Co. group with a true interest cost of 5.2493%.

Merrill reported all bonds sold by late afternoon.

Serial bonds were reoffered to investors at yields ranging from 2.75% in 1994 to 5.35% in 2009.

The issue is insured by the Financial Guaranty Insurance Co. and rated triple-A by Moody's, Standard & Poor's, and Fitch Investors Service.

Secondary Markets

Traders reported brisk activity once the 10-year Treasury note sale concluded.

In secondary dollar bond trading, prices were quoted up 1/4 to as much as 5/8 point, traders said.

In late action, Charlotte Convention Center AMBAC AMT COP 5 1/4s of 2020 were quoted at 5.55% bid, 5.52% offered; Philadelphia Water MBIA 5 1/4s of 2023 were quoted at 5.60% bid, 5.57% offered; and Washington Public Power Supply System MBIA 5.70s of 2017 were quoted at 99 3/4-bid to yield 5.71%. Fulton-DeKalb County Hospital MBIA 5 1/2s of 2020 were quoted at 98-1/4 to yield 5.64%.

In short-term note trading, yields were mixed on the day.

In late action, California Rans were quoted at 2.98% bid, 2.95% offered and New York State notes were quoted at 2.60% bid, 2.55% offered.

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