The tax-exempt market struggled to hold up under the weight of supply this week as traders said yields continue to climb.

"Buyers continued pulling bids back and more sellers hit bids off from recent days," wrote Dan Toboja, vice president at Ziegler Capital Markets. "Overall the stability that appeared to be in the market Thursday morning was gone by midday. By the close of trading bids began to slowly flow back into the market."

Traders continued to react to the downgrade of Puerto Rico and said the market could be volatile for a while, but buyers will not avoid Puerto Rico debt altogether. "With several large mutual fund holders of PR debt it will likely cause some pain as NAVs are taken down," Toboja said. "However, with such solid fund flows, a slew of redemptions submarining the market does not appear imminent. So it seems unlikely to cause as severe a market shock as something like the broad tobacco downgrades in 2011."

On Thursday, yields on the Municipal Market Data scale jumped as much as six basis points and have increased as much as 20 basis points over the week.

The 10-year yield jumped four basis points Thursday to 1.66% and has risen 18 basis points over the course of the week. It now trades 19 basis points above the record low of 1.47% set Nov. 28.

The 30-year yield spiked up six basis points Thursday to 2.65% and has risen 17 basis points over the course of the week. It now trades 18 basis points above its record low of 2.47% set Nov. 28.

The two-year finished flat at 0.30% for the 54th consecutive trading session.

In a stark reversal, Treasuries were stronger Friday morning after weakening for three consecutive trading sessions. The benchmark 10-year yield and the 30-year yield fell four basis points each to 1.70% and 2.87%, respectively. The two-year yield fell two basis points to 0.24%.

In economic news, the consumer price index fell 0.3% while the core figure was up 0.1% in November.

"This report will help reassure the doves at the Fed that they are not taking significant risks with inflation by expanding QE3 and linking forward guidance on the funds rate explicitly to unemployment and their outlook for inflation," wrote economists at RDQ Economics. "With inflation below the Fed's expanded tolerance and the unemployment rate above their estimate, the Fed will see no reason not to remain aggressive on expanding the balance sheet."

In other economic news, industrial production rose 1.1% in November while capacity ticked up 78.4% in November. The production increase was larger than the 0.3% increase economists had expected and capacity use was higher than the 78% expected.

"The gyrations in manufactured output in October and November are largely the result of Hurricane Sandy and its impact," RDQ economists wrote. "We struggle to make sense of the data that show a massive Sandy impact in October that largely vanished in November."

They added, "Putting aside Sandy-induced volatility, the real takeaway should be that manufacturing has grown only slowly over the last three months. The impact of uncertainty over the fiscal cliff on capital spending is supported in this report by the decline in business equipment production over the last three months."

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