The strong bond market rally that has endured since October, plus technical factors above and beyond the market's ability to control, have created some topsy-turvy situations in the fixed-income markets. Although we can speculate on how they might be resolved, the outcome is far from certain. Consider the following aberration in the municipal market.

In 1985, the House passed a tax revision bill, HR 3838, that severely limited the issuance of tax-exempt securities, effective Jan. 1, 1986. The complex bill laid down guidelines that would make tax-exempt securities issued in 1986 taxable if certain procedures were not met.

As expected, the uncertainty caused by the legislation has reduced the volume of new issues so far in 1986 to a trickle. In anticipation, first, of HR 3838 and, second, the dearth of new issues in 1986, investment bankers marketed a record $171 billion of tax-exempt securities in 1985, with a very large amount having been sold during the last quarter of 1985. This glut of municipals created what arbitrageurs thought was a dream.

In early December, the 30-year T bond was yielding 9.90 percent. A single-A-rated Intermountain Power Authority (IPA) revenue bond due in 2019 was marketed with a tax-free return of 9.35 percent.

The ratio of the tax-free yield to the taxable yield was 94 percent (9.35 percent divided by 9.90 percent). Historically, this ratio traveled mostly between 80 percent and 90 percent. Therefore, the arbitrage to do was to sell the 30-year T bond short and to purchase the IPA issue, which arbitrageurs reasoned would outperform the T bond, especially because there would be a very light municipal supply in 1986.

This "arb" in particular, and many trades similar to this, were done so widely that some professionals felt the market would be flooded with municipals in 1986, when the arbitrageurs and traders revised this type of trade.

But the T bond in the current rally far outperformed the IPAs as well as other municipals. The T bond is about 16 points higher since December, while the IPAs are 13 points higher. The yield ratio moved in the wrong direction.

This predicament raises an intriguing question. The Senate Finance Committee has accepted a proposal to change the effective date for the proposed tax revision legislation from Jan. 1, 1986, to Jan. 1, 1987. This means that, possibly within a few weeks, the floodgates may be opened for the issuance of new municipals. Now, the market, faced with real supply for the first time in almost three months, must determine if municipals are cheap -- because some ratios are as high as 100 percent or even greater -- or if bonds should be purchased now, with the market some 13 points higher than it was at the end of 1985. It's the classic question: Does the money chase the product or does the product chase the money?

The Treasury will auction a two-year note on Wednesday in $5,000 minimums. They should return 7.15 percent.