The performance of the municipal bond market in 1990 was good but not spectacular. An atmosphere of declining interest rates, caused by a weakening economy and Federal Reserve efforts to lower rates in the last quarter, produced a positive total return.

Tracking the Bond Buyer's 20 Bond Index, the municipal market went from a low yield of 7.03 percent in early January to 7.54 percent May 4, then moved to lower yields until Aug. 2. The market moved to a new high of 7.56 percent in August and October before falling to 7.05 percent in mid-December and 7.14 percent at year's end.

The longer Bond Buyers' Revenue Bond Index followed the same course, with a low yield of 7.35 percent in early January and a high of 7.83 percent Oct. 12, closing the year at 7.39 percent. From the standpoint of total return (price appreciation plus coupon), across the entire yield curve, the average gain was about 5.50 percent.

The main story for 1990 was, and very likely will be for 1991 as well, the credit deterioration of state and local governments. During 1990, Standard & Poor's Corp., the credit rating agency, downgraded about four times as many issues as it raised. Peter Gordon, director of the municipal division of T. Rowe Price, said the reason for the credit problems of state and local governments is their unexpectedly low revenue. During 1990, 30 states came up short on revenue, and Gordon predicts as many as 38 states will face that situation this year.

The credit concerns are reflected in widening yield spreads between high-grade municipal bonds (AAA/AA) and lower-grade bonds (A/BAA). Last January, the spread was 20 basis points. Today, it's 50 basis points, and Gordon believes that it could widen to 100.

Gordon recommends staying with high-quality bonds until spreads have widened further. He also suggests staying away from BAA-rated issues entirely until spreads are close to 100 basis points and suggests using caution with A-rated issues. Because further declines are expected in short- to intermediate-term interest rates, Gordon likes the five- to 10-year maturity sector instead of the 20- to 30-year sector.

The Treasury will auction two Resolution Funding Corp. issues Tuesday in $1,000 minimums. One issue will be a reopening of the outstanding 40-year bond that matures on April 15, 2030. The second issue will mature in 30 years. The Treasury will auction a seven-year Treasury note Wednesday in $1,000 minimums. These issues should return 8.38 percent, 8.35 percent and 7.92 percent, respectively.