In the past two weeks, the fixed income markets have undergone a dramatic change in direction and psychology.

In the wake of high inflation, continuous growth in the money supply and a questionable dollar, the Federal Reserve has raised the discount rate (the rate the Fed charges its members to borrow funds) to record levels and have pushed the Federal Funds rate (the rate member banks charge for use of their free reserves as well as the rate that the Fed directly influences by buying or selling Treasuries) to over 11 percent.

Short rates have not really adjusted to this new Fed funds level and could move an additional 15 to 25 basis points (a basis point is one one-hundredth of a percentage point) higher. Still, most short-term rates are way below their 1974-'75 highs.

The new 2 year Treasury note came with an average return of 9.65 percent last week. So there has been a rippling effect out into the longer maturities.

Due to a lack of supply and activity the markets drifted aimlessly early last week. Three large unsold issues that were overhanging the markets were freed to trade in the open market and prices began to fall.

The $300 million Northwestern Bell Telephone issue had sold poorly because of a change in its call feature. Originally priced to return 9.53 percent, the bonds declined to return 9.64 percent.

The unsold bonds of the state of California and the Massachusetts Wholesale Electric revenues when freed up fell in prices and helped depress the tax-exempt market.

On Thursday, Fed Chairman Paul Volcker stated there was no way interest rates could be lowered until the inflation rate declined. Later that day the release of the monetary aggregates showed further growth and the fixed income markets declined more.

So it would appear that fundamentals are once more moving rates higher. This will be particularly true of the tax-exempt market. During the period after Labor Day many housing bonds and pollution-control loans will be offered at very attractive rates. So buying opportunities are on the way. This column next week will offer some insight into housing bonds.

The corporate market will be quiet until after Labor Day. The Treasury will offer a 4-year, 8-month note in minimum denominations of $1,000 this Tuesday. Subscriptions may be entered at the U.S. Treasury in Washington or one of the Federal Reserve banks elsewhere. A price guesstimate would be 9.12-9.22 percent.

The money market funds are returning around 10 percent once again. This could be a good place to be as the current rise in rates continues. But for those investors interested in tax-exempt bonds, some lengthening into longer maturities in September and October is in order.