The fixed income markets have for the time being run out of gas. The dramatic downward move in interest rates has been accomplished in just over two months. Now the Federal Reserve must wait to see if the tax cut of July 1, along with the new lower interest rate levels, are successful in reviving the economy.

Two obstacles stand in the path to lower rates over the next several weeks: the growth of the money supply and a large supply of new Treasury and municipal issues. The current feeling among savvy bond traders is that the Fed, for both domestic and international reasons, cannot afford to allow interest rates to return to the high levels that prevailed before the June rally. However, with the Treasury having four large issues to sell before the end of September -- a two-year this week and four-, seven- and 20-year issues the following week -- and with these issues coming in the face of risinq monetary growth, it is quite possible that interest rates could move somewhat higher through mid-October. If that occurs, a buying opportunity would present itself to those who missed the rally and for those who just wish to lengthen out a few years.

On top of this, the 30 day municipal calendar has grown to over $3 billion along with dealers having over $1 billion in merchandise on their shelves. Obviously, this is not a time for dealers to be too aggressive in bidding on the new issues. Therefore, the municipal market could also see interest rates move higher near term.

And hiqher municipal rates would make an already attractive investment that much more attractive. James Kochan, Merrill Lynch's municipal research specialist, points out that long-term municipals are a good purchase, for two reasons. Since late last year, the ratio of yields on long high-grade municipals to yields on long governments has varied between .82 and .89, which is substantially above the peak level of 1974-75, which was .83. Currently, that ratio is an attractive .84 (10.25 percent divided by 12.13 percent). The similar ratio on 10-year maturities is .72, high by past standards but just close to the average of .73, but way down from the maximum of .89 that was reached earlier this year.

Kochan also points out that an exceptionally steep yield curve further shows the attractiveness of long municipals. Currently, the yield curve of prime AAA rated municipals runs from 6.25 percent in one year to 10.25 percent in 30 years -- for a 400 basis point spread. Prior to the latest rally, that spread was a wide 385 basis points. According to Kochan, a normal spread at this phase of a bond rally lies somewhere between 250 to 300 basis points. The final stage of a municipal rally will occur when fire and casualty insurance companies, which have been absent from purchasing municipals while seeking rate increases, finally enter the market and cause the yield spreads to narrow even more. Consequently, with the yield curve spread as wide as it now is, and with the ratio of municipal yields to government yields as high as they are, Kochan concludes that lon9er municipals are super purchases.

Finally, for those sophisticated buyers of tax-free issues who can take risks, Kochan points out that the most attractive credits to buy are the long-term A and BAA rated general obligation bonds. In spite of the recent rally, the quality spreads between long-term high grade triple As and long medium grade BAAs has widened from 150 basis points in January to 260 basis points in September. This widening may be attributed to fears of bankruptcies. Kochan stresses that issue selection is critical for those dealing in lower rated securities. He suggests smaller local issues that are rated A or BAA and will never enjoy a much higher rating because they are only cities, counties or sewerage districts, even though their credit analyses may be good. Kochan further reasons that when the market improves these wide spreads will narrow and the yield curve will flatten, all of which will enhance the overall return to the investor.

This week will see several large high-grade municipal issues offered. On Wednesday, a two-year Treasury will be auctioned in minimum denominations of $5,000. They should return around 12 percent.