Munis Unchanged With a Bit of Firmness

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The municipal market was unchanged with a slightly firmer tone yesterday.

"There is some buying on the short end, but not much happening on the longer end," a trader in New York said. "Overall though, it's pretty quiet, and I'd say we're flat. The short end has come in a bit so far with demand, but it's hard to gauge, so on the whole, I'd call it unchanged. Nobody's getting any great deals out long, that's for sure."

Trades reported by the Municipal Securities Rulemaking Board yesterday showed some gains. A dealer sold to a customer Massachusetts Health and Education Facilities Authority 5.5s of 2036 at 4.97%, three basis points lower than where they were sold Friday. A dealer sold to a customer insured Port Authority of New York and New Jersey 4.75s of 2026 at 6.18%, even with where they traded Friday. Bonds from an interdealer trade of insured Miami-Dade County 5s of 2038 yielded 5.58%, three basis points lower than where they were sold Friday. A dealer bought from a customer insured Greenville, S.C., School District 5s of 2025 at 4.92%, even with where they were sold Friday. A dealer sold to a customer Los Angeles Department of Water and Power 5.25s of 2038 at 5.23%, one basis point lower than where they traded Friday. Bonds from an interdealer trade of New York's Metropolitan Transportation Authority 6.5s of 2028 yielded 5.95%, even with where they traded Friday.

The Treasury market mostly showed losses yesterday. The yield on the benchmark 10-year note, which opened at 2.36%, finished at 2.48%. The yield on the two-year note was quoted near the end of the session at 0.79% after opening at 0.82%. The yield on the 30-year bond, which opened at 2.80%, was quoted near the end of the session at 3.01%.

With the wreckage of 2008 in the rearview mirror, issuers will start boosting the supply of muni debt this week as investors continue their flight to quality.

In the first full week of the year, more than $3.1 billion is expected to go to market, according to Thomson Reuters, with $10.6 billion still in the day-to-day mode from last year.

New York's Empire State Development Corp. tops all issuers with $1.1 billion of personal income tax bonds in both tax-exempt and taxable modes. The deal will be priced by Citi on Thursday after a retail order period today and tomorrow.

In a weekly report, Matt Fabian, managing director at Municipal Market Advisors, wrote that "although the start of a new year traditionally brings a rally to the muni market, meaning both lower benchmark yields and tighter credit spreads, this year the market is already quite rich from year-end positioning, and MMA's technical indicators are signaling near-term price volatility."

"In addition," Fabian wrote, "muni demand - which still lacks a systematic institutional component - has been outmatched by any sustained supply, and issuers are planning and needing a large new-issue calendar through month-end. This could mean that, more likely, any rally-related gains will be short lived or, less likely, they must come with more sweeping changes to how munis are priced and valued.

"The 2009 muni market, if left untouched, will be prone to evolution into a smaller, more plain-vanilla system oriented toward capital finance for states and higher-rated issuers," Fabian continued, "although this would exacerbate credit and liquidity problems for smaller, risky sector issuers and thus needs to be addressed via federal legislation and policy changes."

Fabian also wrote that the municipal market's "quest for 2009 is finding a more persistent vein of institutional demand."

"Former institutional vectors remain weak: accounts that buy tax-exempts to shield profits from taxes have both fewer profits and, with this weekend's news of potential tax cuts, perhaps less need for munis," he continued. "Accounts that buy munis for leveraged return have been chased out of the market by losses or more stringent risk guidelines - leverage cannot be expected to carry muni demand in 2009 and still brings risk of secondary market selling pressure; accounts that buy munis for total return have many attractive, taxable alternatives that do not carry the current headline risk in buying California, Puerto Rico, or Illinois bonds; and mutual funds are still facing investor outflows, although at some point this may at least stabilize if not reverse."

Fabian added that, "importantly, institutional demand will also be constrained by worsening pricing and credit issues, both of which show little sign of abatement in the first quarter of 2009."

"Munis would provide a reasonable performance alternative to Treasuries should government bonds begin to weaken on supply; however, there is enough uncertainty in the much-discussed 'Treasury bubble' to ward off early adopters of a Treasury-shorting strategy," Fabian wrote.

In economic data released yesterday, construction spending fell 0.6% in November after a revised 0.4% decline the previous month. Economists polled by Thomson Reuters had predicted a 1.3% drop.

A slate of additional economic data will be released this week, with the December non-farm payrolls report closing out the week on Friday. Aside from that, the Institute for Supply Management's December non-manufacturing business activity composite index will be released today, in addition to November factory orders. Initial jobless claims for the week ended Jan. 3 and continuing jobless claims for the week ended Dec. 27 will be released Thursday, and Friday will see the payrolls report, November wholesale inventories, and November wholesale sales figures.

Economists polled by Thomson Reuters are predicting a 500,000 decline in non-farm payrolls, a 37.0 ISM non-manufacturing index reading, a 2.5% decline in factory orders, 540,000 initial jobless claims, 4.500 million continuing jobless claims, and an 0.8% drop in wholesale inventories.

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