"A spectacular rally" is how one municipal salesman described the activity in the bond market for the last two weeks. A government trader declared, "the bond market's back and everyone love it."

Indeed the bond markets have turned in a spectacular performance. Long Treasuries have rallied 6 points since their record lows at the end of August. Over the dame period, the Washington Public Power System's AAA, 15 percent tax-exempt issue has jumped 10 points ($100 for each $1,000 bond) in price. The same is true in the corporate market, although there has been a scarcity of new issues.

Short-term interest rates have followed the 200-basis-point decline in the federal funds rate. In fact, it's the decline in the federal rate that has helped to fuel the rally with the notion that the Federal Reserve has eased credit in the banking system. Fed chariman Volcker, however, pointed out emphatically that the current decline in rates does not mean the Fed has eased up. In fact, he said, the tight-credit policy will continue. So, is the market all wet or is the market clairevoyant?

The market was in such a euphoric state that the Bond Buyers' Index for municipals declined for the first time since it began its continual weekly rise the first week of June. The municipal market was in a very oversold position and it is understandable that it has rallied so well. But many of these recent tax-free issues had been sold short (dealers sold bonds they did not own with the idea of purchasing them back at lower prices for a profit) and the unexpected rally caused the prices of these scarce bonds to skyrocket as dealers scurried to cover their short positions.

Missing in all the enthusiasm was any talk about inflation, budget deficits, the huge Treasury financings waiting to come on stage or any other subject detrimental to the market. Market participants basked in the sun and enjoyed the rising prices and falling interest rates. The surge in prices has been accomplished with very low new-issue volume. The only sizeable issue, the two-year Treasury, produced a sloppy auction with less than the usual interest shown by individuals.

By Thursday, the corporate calendar for this week had sprouted from nowhere to almost $1 billion. The municipal market has good supply scattered over the next several weeks, especially in power authority bonds. The current rally could several of these issues to be accelerated for a near term sale. There is also a four-year Treasury that will be sold Wednesday in minimums of $1,000.

The real test of the market will be at hand. Will institutions join in buying bonds? Will the supply build to the point where it cannot be absorbed? Will buyers buy at lower returns? Will sellers appear to reap their quick profits (a rarity nowadays)? And, how long before investors begin to think again about deficits, budget cuts and inflation? In short, is the rally technical in nature or the real thing? With answers to these questions we'll have a much better idea of the market's direction. We should have the answers by the first week of October, if not sooner.

Howard County, Md., will offer $32 million in general obligation bonds for sale on Tuesday. These tax-exempt bonds will mature yearly from 192 through 2006, and will be rated AA.