One of the black market stores sells them. Also, you will find them here and there - there are some in the fountain outside Garrett's slum every time you leave home, and there is one in a leaky pipe in the area near the two merchants, in the area of the City that has the Hammer church. Look for places that would have water in them (fountains, wells, pipes) for a free supply. Otherwise check out the merchants. But only one of them sells water arrows.
No fancy-pantsy Elven dagger-twirlers. Just tough guys.