Munis Weaker on 'Very Quiet' Monday

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The municipal market was weaker yesterday in light activity.

"It's extremely quiet," a trader in New Jersey said. "It's a quiet Monday in the summer. It's probably a tad bit weaker."

"It's very, very quiet," a trader in New York added. "It went out Friday without a good tone, and there's no reason to think it's changed. You've got some financing issues and the insurance downgrades, among other things."

The Treasury market was mixed yesterday. The yield on the benchmark 10-year Treasury note, which opened at 4.17%, finished at 4.16%. The yield on the two-year note was quoted near the end of the session at 2.96% after opening at 2.90%.

Today, the Federal Reserve will begin a two-day policy-setting meeting on interest rates, with a decision expected tomorrow. Although economists don't expect a rate change, the market will look very closely at the Fed's statement for its thoughts on inflation.

"The language is going to be scrutinized pretty closely," said Jonathan Basile, an economist at Credit Suisse. "It would be pretty surprising if hawkish language doesn't make the statement. They've sort of prepared the market for that."

Prices on options on federal funds futures implied the market sees more than a 90% probability the Fed will keep rates steady at 2.0% at its June meeting, according to the federal funds futures traded on the Chicago Board of Trade, a proxy for market expectations, at 3:45 p.m. Eastern Daylight Time yesterday. The implied probability the Fed keeps rate the same during its August meeting is near 70%. But fed fund futures rates show about an 89% probability there will be at least a 50 basis point increase in the target rate by the end of the year.

A slate of economic data is ahead this week. May durable goods and new home sales data will be released tomorrow, followed Thursday by the final first-quarter gross domestic product, initial jobless claims for the week ended June 21, continuing jobless claims for the week ended June 14, and existing home sales for May. On Friday, May personal income and personal consumption, the May core personal consumption expenditures deflator, and the final June University of Michigan consumer sentiment index will be released.

Economists polled by IFR Markets are predicting no change to durable goods, an 0.8% dip in durable goods excluding transportation, 515,000 new home sales, a 1.0% annual rate for first-quarter GDP, 380,000 initial claims, 3.100 million continuing claims, 5.0 million existing home sales, a 0.4% rise in personal income, a 0.7% increase in personal consumption, a 0.2% uptick in the core PCE deflator, and a 56.9 Michigan sentiment reading.

In the municipal market, Matt Fabian, managing director at Municipal Market Advisors, wrote in his weekly report that "bond insurance drama and the looming quarter-end is helping unwind former bubble-like pricing for high-grade muni paper."

He wrote that insurer downgrades have taken their toll on the market, with lower demand for floating- and fixed-rate offerings, "money markets taking out former [aggressive] positions in wrapped paper," and dealers conceding on price in the primary market to avoid getting stuck with unsold inventory. In addition, Fabian wrote, "investor aversion has precipitated near record levels of bonds for sale in the secondary." He expects yields to rise through quarter-end.

George Friedlander, managing director and fixed-income strategist at Citi, also noted in his weekly report the "uneasiness" in the municipal market caused by the insurer downgrades. He wrote that "paper insured by all but the strongest insurers is now trading based on its underlying rating." In addition, yields have risen to 7.5% to 8% on weekly floaters insured by MBIA Insurance Corp. or Ambac Assurance Corp. because "money market funds will generally no longer hold them."

A $1.5 billion California general obligation sale headlines this week's activity in the primary market amid an estimated $6.46 billion in new-issue volume. Last week, the market welcomed a revised $7.28 billion, according to Thomson Reuters.

As California legislators continue to seek solutions for the state's budget crunch, Citi is expected to price the GO bonds today. The deal is structured to mature serially from 2009 to 2028 with term bonds in 2033 and 2038, and is rated A1 by Moody's Investors Service and A-plus by Standard & Poor's and Fitch Ratings.

In the new-issue market yesterday, First Southwest Co. priced $150 million in unlimited-tax school building bonds for the Comal Independent School District in Texas. Current interest bonds totaling $147 million mature from 2016 through 2029, with term bonds in 2033, 2034 and 2038. Yields range from 3.93% with a 4% coupon in 2016 to 5.07% with a 5% coupon in 2034. The bonds are callable at par in 2018.

The offering also includes $3 million in premium capital appreciation bonds maturing from 2011 through 2015, with yields ranging from 3.49% in 2011 to 4.25% in 2015. All bonds are insured by Texas' Permanent School Fund guarantee program and have underlying credit ratings of Aa3 from Moody's and A-plus from Fitch.

Finally, the Elmbrook, Wis., School District competitively sold $31 million of general obligation school building and improvement bonds to Prager Sealy & Co. with a true interest cost of 4.59%. The bonds mature from 2009 through 2028, with yields ranging from 2.30% with a 4% coupon in 2009 to 4.93% with a 5% coupon in 2028. The bonds, which are callable at par in 2028, are rated A1 by Moody's.

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