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California kicks off $14 billion debt sale

By Hibah Yousuf, staff reporter


NEW YORK (CNNMoney.com) -- Cash-strapped California kicked off a $14 billion debt sale Monday, amid weakening demand for municipal bonds as investors fret that ballooning deficits could trigger cities and states to default on their debt payments.

Yields on municipal bonds have been rising in recent weeks as state and local governments issue debt to boost liquidity as they struggle to trim deficits and balance budgets, said Matt Fabian, managing director at Municipal Market Advisors.

The consulting firm's index that tracks prices of AAA-rated 30-year municipal bonds jumped 0.15 percentage points last week, which was the biggest jump in 18 months. Bond prices and yields move in opposite directions.

"We're seeing a huge supply of municipal debt coming to the market this week, almost twice as much as usual," Fabian said. "The increased supply is adding pressure on the market."

California, which is trying to address a $25.4 billion budget hole, began to take orders from retail investors Monday on $10 billion in short-term notes. The state also is on tap to issue $2 billion in taxable bonds as part of the Build America Bonds program, $1.75 billion in general obligation tax-exempt bonds, and $275 million in bonds backed by public works, all before Thanksgiving.

Growing concerns about state and local fiscal troubles could further weaken demand for municipal debt, translating into lower prices and higher yields, particularly since demand is dominated by retail investors.

"About 75% of all new issues are being bought by individual investors, who are more sensitive to headlines in the news that suggest cities and states are in deep fiscal trouble, so we could see more volatility going forward," said Kenneth Naehu, managing director and head of fixed income at Bel Air Investment Advisors.

Naehu said that while municipal bonds are no longer in their "golden age," and default risk for cities and states will rise, the majority of high-grade municipals are safe bets.

"We hear news that suggests that California could get to a point where they don't pay you because of a very large deficit, but that's pretty far from the truth," he said. "Bond holders in California are second in line to education, and that typically means the state has eight times the amount it needs to make debt payments."

Treasuries: Demand for U.S. government-backed debt also fell Monday, as investors were encouraged by a better-than-expected report on retail sales.

The yield on the 10-year rose to 2.93% from 2.76% Friday, putting it near its highest levels since August.

The 30-year bond yield increased to 4.39%, the richest it's been since May.

The 5-year note's yield rose to 1.5%, while the 2-year's edged up to 0.53%.  To top of page

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