The municipal bond market has been on a roll since the week of May 22. During that week, the Bond Buyer's 20-bond index of high-grade bonds peaked for the year, touching 8.31 percent, while the companion Bond Buyer's revenue bond index hit a yearly high of 8.68 percent. Since then, the tax-exempt market has outperformed the treasury market with the bond index currently at 7.63 percent and the revenue index at 7.96 percent.

Specialists feel that several factors contributed to this rapid market turnaround. The new-found stability of the dollar is one factor that helped the fixed-income markets reverse themselves. The tax-free market closely follows the ups and downs of the treasury market. The firmness of the dollar, plus a couple of weak economic numbers, helped to propel treasury prices higher, and municipal bond prices followed in hot pursuit. Concurrently, there was a dearth of new muni issues, and dealers' bond inventories, as measured in the pages of the Blue List, sharply declined.

Further, with the close of the economic summit in Venice, and with the designation of a new chairman of the Federal Reserve, two uncertainties that had been hanging over the market were removed.

In light of this, dealers were willing to bid ahead of the market for the new issues in hopes that the market would catch up to the higher prices and lower yields. Also prompting this strong bidding for the reduced volume of new issues was the knowledge that $1.5 billion had been raised in an underwriting, the proceeds to be used to purchase municipals for a closed-end bond fund that will trade on the New York Stock Exchange.

One result of all of these events is that the yield spreads between revenue and general obligation bonds have become compressed. At the same time, the yield spreads between the various quality ratings have also become narrower. This week, a $300 million State of Georgia and a $200 million Commonwealth of Massachusetts general obligation issue will sell, and the following week, a $200 million State of Minnesota general obligation issue will be offered.

As a result of this increased supply of high grade issues, the yield spreads between general obligation and revenue issues, as well as between the quality ratings, should become even narrower. This should allow investors to upgrade their holdings and switch from a revenue issue to a general obligation issue without giving up too much yield.

James E. Lebherz has 28 years' experience in fixed-income investments.