The municipal market was slightly firmer in light trading yesterday, following Treasuries. Traders said the market was firmer by one to two basis points. “The markets are starting to catch up but they are disjointed,” a trader in San Francisco said. “As the days have gone on, the fears about the insurance companies have abated to some extent. However, credit or evaluation of the underlying credit is back in vogue for the first time in more than 10 years, from the retailer to the tier-one buyer. What is happening now, over the last couple of days, it is starting to normalize to a certain extent.”“Everything is credit-specific and not as liquid or quick as you would expect,” a trader in Chicago said. “I think a lot of the bigger firms whose fiscal year ended Nov. 30 are potentially back in the market. Munis have been lagging for some time, and they still are, but with these levels I think we can expect buyers to be in the market.”“Again, I would emphasize that a lot of managers of money are concentrating more on their problems than they are their opportunities,” the Chicago trader added. “For those with clean balance sheets, it makes it even more of a good time to get involved.”Trades reported by the Municipal Securities Rulemaking Board yesterday were narrowly mixed. Bonds from an interdealer trade of California 4.25s of 2020 yielded 4.36%, up one basis point from where they traded Friday. A dealer sold to a customer insured Central Puget Sound Regional Transportation Authority, Wash., 5s of 2009 at 3.29%, up two basis points from where they traded Friday. A dealer sold to a customer Florida State Board of Education 5s of 2011 at 3.33%, down one basis point from where they sold Friday.The Treasury market showed some gains yesterday. The yield on the benchmark 10-year Treasury note, which opened at 3.94%, closed at 3.88%. The yield on the two-year note was quoted near the end of the session at 2.90% after opening at 3.01%.Despite municipals being historically cheap to Treasuries, and finding some stability in the last few days, a number of factors — disinterest from institutional and alternative investors, continued volatility in the Treasury market, and yield levels that remain far from the retail investors’ sweet spot — are contributing to keep the market off balance and underperforming.“Although prices have been rising, longer-term demand for muni bonds remains in question, and we see a growing risk to our sector through the end of 2007,” Matt Fabian, managing director at Municipal Market Advisors, wrote in a weekly report. “This follows persistently higher volatility in the taxable fixed-income markets that limits institutional investors’ ability to hedge their muni portfolios against interest rate risk.”Also working to undercut any long-term firmness in the market, the new-issue calendar features the largest volume in a month. Supply will balloon to $10.1 billion this week, led by competitive offerings from the Alabama Public School and College Authority and Pennsylvania. The estimate is 34% higher than the $7.5 billion of paper priced in the new-issue market last week, and marks the largest scheduled calendar since $15.8 billion of debt was brought to market the week of Oct. 22.Why so much supply in such an uncertain market?It’s most likely due to the expectations of dealers, who feel that this is the best time before the end of the year to bring issues to market, especially with munis being so cheap to Treasuries. However, Fabian thinks there are plenty of reasons why demand may not be as robust as some people think. “With current ratios implying that munis are extremely cheap versus taxable alternatives, dealers may be expecting that new product will elicit demand from hedge-oriented investors and thus lend a positive influence to muni valuations,” Fabian wrote. “This may well be correct, but new purchases will follow large losses by this same investor class, in particular tender option bond programs.”He expects those programs, including those managed by proprietary desks, to remain risk-averse and less hungry for paper through the end of they year. And while individual investors have entered the market is recent weeks, attracted by the relative value, they are unlikely to provide enough support for the new paper.“Individual investor activity has become stronger as munis have cheapened relative to taxable benchmarks,” wrote George Friedlander, managing director and fixed-income strategist at Citi. “Nevertheless, individual investor demand will not be sufficient, by itself, to handle the heavy calendar in the coming weeks. So, a further upward rate adjustment going into the heavy issuance period is certainly a possibility.”Despite this, Friedlander believes the heavy supply could actually help the market by providing some direction.“The arrival and placement of the heavy calendar, once it occurs, could ultimately prove to be a net positive for the muni market,” he wrote. “Heavy issuance will tend to improve 'price discovery’ in a market that seems to be having difficulty figuring out what various issuers and maturities are worth.”In the new-issue market yesterday, there was little indication of how the week will play out. Triple-A rated Overland Park, Kan., competitively sold $65 million internal improvement bonds to Piper Jaffrey & Co. with a true interest cost of 3.91%. The bonds mature serially from 2008 to 2027, and are callable at par in 2017. Further pricing information was unavailable. In economic data released yesterday, the November Institute for Supply Management’s manufacturing index came in at 50.8, after a reading of 50.9 the previous month. Economists polled by IFR Markets had predicted a reading of 50.4.
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