America's strapped states and cities took another hit Wednesday, with California seeing tepid demand for its latest bond sale and other governments pulling about $700 million worth of borrowing deals this week as investors continued stepping away from the municipal bond market.

The normally staid market has grown volatile the past week, posting its sharpest selloff in nearly two years, as investors demand higher interest rates to buy paper issued by states, cities and counties to finance their operations. Localities have been...