Much of the downward pull was because of weaker Treasuries prices, according to Chris Mauro, a muni market strategist at RBC Capital Markets, but the battle over extending BABs legislation was an underlying negative as well.
Prices fell enough to lift yields as much as 10 basis points on long-term tax-exempt bonds, according to a preliminary read by Municipal Market Data.
"BABs uncertainty doesn't help matters," Mauro said, adding that reports early on Tuesday out of Congress "were not encouraging if you are a BABs fan."
Congressional Republicans will block any inclusion of Build America Bonds, a taxable bond program popular with states, cities and other muni issuers, in the tax deal they clinched with President Barack Obama, a Republican aide said on Tuesday.
"We have a very firm line on BABs -- we are not going to allow them to be included," a congressional Republican aide said.
At the same time, the White House and a Democratic aide said the issue was still on the table.
"It's one of a handful of unresolved questions at the moment," said the Democratic aide, referring to the taxable bonds created by the federal economic stimulus act that are due to expire at year-end.
The dispute underscores the tension between Democrats, who feel they were left out of the deal extending Bush-era tax cuts that Obama spelled out Monday night, and Republicans.
Mauro said the BABs program was not dead as yet.
"At this point, the market sort of anticipates this thing will go down to the wire," he said.
Prices of BABs in the secondary market are holding up, but the primary market for BABs seems weaker, according to MMD analyst Domenic Vonella.
"It's a bifurcated market, where secondary prices are steady or even a little better," he said, adding that indications of interest for $1.5 billion of New Jersey Turnpike Authority BABs were at a spread of 287 basis points over comparable Treasuries for bonds due in 2041. That is higher than the plus-233 basis-point spread in the secondary market a few days ago for New Jersey, he said.
Uncertainty over the future of the BABs program has weighed on the $2.8 trillion U.S. municipal market, contributing to a big price drop last month as issuers rushed to sell the bonds before the program expires.
The BABs program has been popular because of the 35 percent federal rebate issuers receive on interest costs for their debt. Since their debut in April 2009 more than $164 billion of BABs have been issued, according to Thomson Reuters data.
Legislation that failed to pass the U.S. Senate over the weekend included a one-year extension of the program with the federal rebate rate lowered to 32 percent.
(Reporting by Richard Cowan, Kim Dixon, additional reporting by Karen Pierog in Chicago and Michael Connor in Miami, Editing by Paul Simao & Padraic Cassidy)