The Treasury market faded Friday after posting gains on a favorable inflation report, but municipals remained strong as demand continued to outweigh supply.

The June producer price index, which measures the amount that manufacturers pay for the goods used in production, rose 0.2%.

Even though the increase was in line with the expectations of 13 economists polled by The Bond Buyer, the boost for prices came from the core rate of inflation.

In June, the core, which is the figure minus volatile food and energy components, fell 0.1%, which marks the first monthly decline since February 1987.

Tax-exempt prices managed 1/4 point gains on average on the heels of the Treasury market. But governments faded later in the afternoon, closing down nearly 1/2 point, and municipal traders responded by hitting the sidelines.

In the debt futures market, the September municipal contract settled up 9/32, to 97.24, while the MOB spread narrowed to negative 153 from negative 167 Thursday as municipals far outpaced Treasuries.

Although traders were nervous about near-term price prospects as the Treasury market fell, they noted that a superior municipal technical position should support the current levels.

"There are things to worry about, but the market should be supply-demand driven more than anything," one trader acknowledged Friday. "It's probably going to fade as we near the August Treasury refunding, but we should stick to this range for at least another week."

New-issue activity was slow Friday, except for one large negotiated deal, priced in the morning.

A syndicate led by Smith Barney, Harris Upham & Co. priced $482 million Southern California Public Power Authority transmission project revenue bonds.

The offering is structured as a combination crossover refunding and advance refunding. The advance refunding bonds will be secured by a subordinate pledge of SCPPA transmission project revenues, while the crossover bonds will be secured by a guaranteed investment contract.

The offering included serial bonds priced to yield from 2.75% in 1993 to 5.70% in 2003. A 2012 term was not formally reoffered to investors; a 2018 term was priced as 6 1/8 s to yield 6.20%; a 2020 term was priced as 5-1/2s to yield 6.15%; and, a 2021 term was priced as 5-3/4s to yield 6.15%.

There also are capital appreciation bonds priced to yield from 6.10% in 2004 to 6.35% in 2015.

The managers said they expected Moody's Investors Service to rate the bonds Aa. and Standard & Poor's Corp. to rate the issue AA-minus.

In other action, Lehman Brothers tentatively priced $75 million of SCPPA transmission revenue and refunding bonds in a derivative financing.

The offering included $37.5 million select auction variable-rate securities, which were not formally reoffered to investors, and $38 million residual interest bonds priced at par as 8.801s in 2012.

The issue is rated Aa by Moody's and AA-minus by Standard & Poor's.

Secondary trading was heavy during the early part of the day as bid-wanted lists and sizable blocks of bonds continued to circulate in the Street.

In secondary dollar bond trading, prices were quoted 1/8 to 1/4 point higher on average. New York City Water Authority AMBAC 6.20s of 2021 were quoted at 99-7/8-100 to yield approximately 6.20% on the bid side, while Texas Municipal Power Agency MBIA 5-3/4s of 2012 were quoted at 94-7/8-95 to yield 6.20%.

Short-term participants said that trading was "choppy" on Friday with investors easing through the afternoon after yields backed up three or four basis points in the morning.

Late in the session, Los Angeles Trans 3-3/4s were quoted at 2.95% bid, 2.90% offered; New York City Trans 3-1/4s were quoted at 2.90% bid, 2.80% offered; San Bernardino Co., Calif. Trans were quoted at 3.13% bid, 3.08% offered; and New York State Trans 3.65s were quoted at 2.80% bid, 2.75% offered.

Looking ahead to supply, only $2.4 billion of securities are expected to be priced this week.

The negotiated sector features $155 million Tucson Unified School District, Ariz., senior managed by Smith Barney, Harris Upham & Co.; $150 million Osceola Co., Fla., transportation improvement revenue bonds, to be priced by Merrill Lynch & Co.; and $122 million Orange Co. Community Facilities District No. 88-1, Calif., special tax bonds, to be priced by Stone & Youngberg.

In the competitive sector, deals to be priced include $75 million Colorado Springs, Colo., revenue bonds, and $48 million Alaska Student Loan Corp. revenue bonds.

The short-term sector's lone large deal is a $380 million Iowa tax and revenue anticipation note issue set to be sold by a group led by Goldman, Sachs & Co. Wednesday or Thursday. The pricing was in doubt last week because of a pending lawsuit filed by an Iowa taxpayers group that aimed to block the sale of the notes. The suit was dismissed late afternoon Friday. (See related story, Page 5).

The suit contended that the state's accounting methods hide from taxpayers a long-term deficit and asks the courts to force Iowa into using generally accepted accounting principles.

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