Municipal prices significantly lagged the treasury sector's 5/8 point fall on unfavorable economic indicators Friday, and activity is likely to remain subdued ahead of this week's unemployment data.

Tax-exempt prices had made modest gains for two sessions in a row until economic data took bonds off the highs on Friday.

In a reflection of the previous week's durable goods data, the July index of leading indicators soared 1.2%, the largest increase in more than three years. New orders for manufactured goods shot up 6.2% in July, the largest increase since a 6.6% jump in December 1970.

The Chicagoland business barometer rose to an unadjusted 54.7% in August from 48% in July. An index reading below 50% signals a slowing economy, while a level above 50% suggests expansion.

Traders said there was very little trading on the news but prices were quoted down 1/8 point in spots. Activity subsided soon afterward as market participants headed home early for the long weekend.

In the debt futures market, the September municipal futures contract settled down 9/32 to 93.22 with the September MOB spread calculated at negative 140.

Short-term note yields fell slightly in anticipation of incoming cash at the end of the month.

In late secondary trading, March California notes were quoted at 4.49% bid, 4.45% offered, while June California notes were quoted at 4.55% bid, 4.50% offered. New Jersey notes were quoted at 4.53% bid, 4.50% offered. March New York State Trans were quoted at 5.13% bid, 5.10% offered.

In the prerefunded bond market, bonds callable in 1995 were quoted at 5.55% bid, 5.50% offered.

The market will likely hold to a range until this week's unemployment figures for August are released. Market observers note that prices are vulnerable to unfavorable economic news, but municpals continue to lag the Treasury sector.

"The market is at very high levels and you're going to have to see some friendly economic data to sustain these prices," said James L. Kochan, head of fixed-income research at Robert W. Baird & Co. "There still is good demand for all securities right now but we need evidence that will prompt the Fed to ease further."

Economists generally expect a weak unemployment number for August, but recent indicators have been mixed adding uncertainty to prospects that the Federal Reserve Board will ease interest rates.

"An ease is a tough call," acknowledged William Sullivan, a money market economist at Dean Witter Reynolds Inc. "We will see what will prove to be a disappointing labor force but it won't be wholesale weakness. But a weak employment number would apply an additional layer of pressure on the Fed to ease policy."

But municipals are enjoying strong demand, despite lower yields, compared to other markets.

George D. Friedlander, managing director of fixed income portfolio strategy at Smith Barney, Harris Upham & Co., notes in the firm's latest newsletter that demand remains strong and that tax-exempts are fairly priced relative to taxable securities.

"The flow of monies out of short-term instruments such as CDs and money market funds into longer tax-exempt instruments shows no signs of abating," he said. "Perhaps most important, there appears to be a massive amount of pent-up demand among individual investors."

Looking ahead to supply, only $489 million of new securities are slated to be priced this week.

The 30-day municipal visible supply totals $1.2 billion, while Standard & Poor's Blue List of municipal bonds is down $123 million to $1.3 billion.

The competitive sector is devoid of any large issues.

The negotiated sector features $155 million Pennsylvania Higher Educational Facilities Authority revenue bonds, to be priced by Lehman Brothers, $64 million Atlantic Co., N.J. certificates of participation to be priced by PaineWebber Inc., and $41 million Tri-City Hospital District, Calif. revenue bonds, to be priced by Ziegler Securities.

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