Municipals continued to rally yesterday, benefiting both from investors who have tax worries and an easing of supply pressure.

The prospect of higher income taxes under the incoming Clinton administration sparked municipal gains for the second session in a row.

Traders attributed 1/4 to 1/2 point gains Wednesday to demand from tax worried investors and the rally gained momentum yesterday as prices rose 1/4 to as much as 3/4 point.

But demand was strongest in the futures market as the December municipal contract settled up 25/32 to 95.03.

Traders reported heavy MOB buying and the spread narrowed dramatically. Moving to negative 232, it fell 77 basis points from negative 309 calculated last Thursday.

The Chicago Board of Trade, meanwhile, reported its Municipal Bond Index futures contract established a new open interest record Oct. 28 with 25,440 contracts outstanding.

Traders say demand increased soon after the election Tuesday as investors sought to find shelter from potential tax increases next year. President-elect Bill Clinton says he favors taxing the rich, and his economic advisers have said this will mean raising the top rate to 36% from 31%.

Adding to the market's allure, numerous news stories and releases from dealers touted the appeal of tax-exempt bonds under a Clinton administration.

"It's really sinking into people's minds that the upper tax brackets will be raised," said one trader. "We're also cheap to governments and supply has dropped off for the moment. It seems like municipals are the only game in town."

For example, under the current 31% top tax rate, an owner of a triple-A municipal bond that yields 5.55% in 10 years would reap a taxable equivalent of 8.04%, according to a release from CoreStates Investment Advisers. The firm reports a 30-year triple-A bond yielding 6.40% has a taxable equivalent of 9.28%.

If the top tax rate is boosted to 36%, the firm notes, owners of the 10-year bond would realize a 8.67% taxable equivalent yield, while the owner of the 30-year bond would garner a 10% taxable equivalent.

Reflecting an improvement in business, the Blue List of dealer inventory fell $161 million, to $1.32 billion.

Weak Economy

Under closer scrutiny, traders said, the most encouraging factor for the market remains the ailing economy.

Few market players expect the economic picture to improve anytime soon, no matter what fiscal stimulus package is offered by the Democratic White House.

Foremost on the market's mind is today's jobs data, which are not expected to harm bond prices.

"We're still vulnerable to the jobs report, but it would have to be a number that was very good for the economy," a trader said. "But that doesn't appear to be in the cards and we will probably have mild reaction to it either way."

Yesterday, initial state unemployment insurance claims fell 16,000, to a seasonally adjusted 360,000 in the week ended Oct. 24.

U.S. nonfarm productivity increased at a 2.6% annual rate in the third quarter, seasonally adjusted, the Labor Department reported.

Underwriters were able to lower yields on most new issues yesterday, reflecting improved investor demand.

"We saw traditional buyers, but also nontraditional players," one market participant said, referring to retail buyers. "If we get through the jobs data and the Treasury refunding, we could have a barnburner until supply increases again."

The Bond Buyer calculated 30-day visible supply at $6.35 billion, where it has held steady for nearly a week.

Leading action yesterday, Morgan Stanley & Co. priced and repriced $131 million of New York State Dormitory Authority revenue bonds for the City University of New York.

At the repricing, serial bond yields were lowered by five to 10 basis points and term bond yields were lowered by five basis points.

The final offering included serials priced to yield from 3.20% in 1993 to 6.56% in 2005. A 2008 term was priced as 6 3/8s to yield 6.70% and a 2009 term was priced as 6 3/4s to yield 6.70%.

The offering was rated Baal by Moody's Investors Service and BBB by Standard & Poor's Corp.

PNC Securities Corp. tentatively priced $107 million of Allegheny County, Pa., Hospital Authority revenue bonds for the Presbyterian University Health System Inc. project.

The offering included serial bonds priced to yield from 5% in 2000 to 6.10% in 2004. A 2012 term was priced as 6s to yield 6.519% and a 2023 term was priced as 6 1/4s to yield 6.622%.

The bonds are insured by the Municipal Bond Investors Assurance Corp. and triple-A rated by Moody's and Standard & Poor's.

Goldman, Sachs & Co. priced and repriced $92 million of Michigan Municipal Bond Authority state revolving fund revenue bonds.

At the repricing, serial bond yields were lowered by five to 10 basis points, while term bond yields were lowered by five basis points.

The offering included serial bonds priced at par to yield from 3.65% in 1994 to 6.45% in 2009. A 2013 term was priced at par to yield 6.55% and a 2018 term was priced at par to yield 6.60%.

The managers said they expect the issue to be rated double-A by Moody's and Standard & Poor's.

Secondary Markets

Traders reported moderate activity throughout the session, highlighted by some sizable trades, including $10 million of Connecticut, GO 6. 10s of 2006, which were said to have changed hands around 6.15% net.

On market observer noted that quality spreads narrowed about five basis points since Tuesday.

"Investors reaching for yield drove yields higher so that bonds with ratings of Al and below improved," one market observer said.

In secondary dollar bond trading, prices were quoted up 1/4 to as much as 3/4 point.

In late action, California GO 6 1/4s of 2019 were quoted at 6.52% bid, 6.49% offered; New York City Water and Sewer 6 3/8s of 2022 were quoted at 96-1/8 to yield 6.686%; and Washington Public Power Supply System 6 1/2s of 2015 were quoted at 98 1/4-5/8 to yield 6.65%.

Puerto Rico GO 6s of 2014 were quoted at 94-1/4 to yield 6.52%; Denver Airport AMT 6 3/4 of 2022 were quoted at 94-1/4 to yield 7.244%; and Florida Board of Education 6s of 2025 were quoted at 93 1/2-3/4 to yield 6.48%.

In the short-term note market, yields rose about five basis points on average, traders said. In late action, New Jersey Trans were quoted at 2.85% bid, 2.80% offered.

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