Munis weaker as market struggles to digest big supply; more than $5 billion of new deals ahead

By Sheri Kasprzak

New York, Jan. 28 - Municipal yields were seen weaker on Monday as the market continued to deal with large balances from the previous week's new-issue supply, market sources said.

Treasuries were also weaker on Monday, putting some pressure on municipals as well.

"There's not a lot trading, and there's still quite a bit of inventory from last week," one trader said.

"Yields are rising on a few deals just to get things done."

In particular, yields were seen up on offerings from the State of Washington and New Jersey Economic Development Authority.

"Absorption is not as quick as it should be," another trader noted.

"We feel that demand is still decent, but yields are adjusting up."

The bulk of what was trading Monday were bonds maturing 10 years and in, indicating that participants are on the defense.

Debt ceiling may be suspended

In other market news, the debt ceiling will likely be suspended, but there are several issues that may bring more interference from Washington, D.C., in the muni markets, said Tom Kozlik, municipal credit analyst with Janney Montgomery Scott LLC.

"Notable for the municipal market is also the scheduled release of the president's budget proposal on Feb. 4, though the release will likely be late because the fiscal cliff agreement was so tardy," Kozlik said Monday.

"This proposal is especially important for the municipal market, since we again expect the president to recommend a 28% cap on munis' tax exempt income, effectively taxing a portion of the interest received by top-bracket taxpayers. ... We do not think that it signifies a renewed effort to squash the municipal bond tax exemption. It is more of a product of the fact that [the] president's budget proposals do not generally change year-over-year. Again, investors should not be surprised if the president once again proposes a 28% cap, but they should not be alarmed yet. The tax-exemption threat is likely to play out over a multiyear period, likely from 2013 to 2015, at least."

S&P downgrades Illinois

Meanwhile, Standard & Poor's cut its underlying rating on the State of Illinois to A- from A. The move comes just ahead of the state's planned $500 million sale of series of February 2013 general obligation bonds.

The state intends to come to market with the G.O. bonds on Wednesday through competitive sale.

The agency's outlook for the state remains negative. S&P noted the state's weakened pension fund ratios and lack of action on reform measures intended to improve funding levels and diminished cost pressures associated with annual contributions.

The G.O. bonds are due 2014 to 2038, and proceeds from the deal will be used to finance school and transportation projects as well as other state capital projects.

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