The flood of US pandemic aid that flowed into state treasuries helped balance budgets and raise bond ratings. Now the question is whether a recession will halt states’ financial progress.
(Bloomberg) — The flood of US pandemic aid that flowed into state treasuries helped balance budgets and raise bond ratings. Now the question is whether a recession will halt states’ financial progress.
“If we have a very deep and sustained recession, we might see the credit quality or the ratings being adjusted,” said Dora Lee, director of research for Belle Haven Investments. “If we have a pretty mild recession, it is highly unlikely that these upgrades will be reversed.”
Illinois, Massachusetts and New Jersey this year have garnered higher credit scores from rating companies, including brighter outlooks for the states as well. The upgrades also helped shrink bond yield spreads in the primary and secondary municipal markets, signaling investor perception of state debt is improving.
The better state ratings are due in part to the positive effect of federal pandemic aid, which some states used for one-time expenses while others set cash aside for the future. State treasuries also saw an influx of tax revenue from residents — bolstered by US stimulus money sent to individuals — who spent on services at home at the height of the pandemic, and on travel after Covid lockdowns were eased.
Still, a slowdown in the US economy this year is causing concern that states can no longer expect a cash haul. The likelihood that the economy in the next 12 months will slide into a recession is greater now than a month earlier, according to a March 20-27 Bloomberg survey of 48 economists.
The poll, conducted after several bank closures roiled financial markets, put the odds of a contraction at 65%, up from 60% in February, amid interest-rate hikes by the Federal Reserve and growing risks of tighter credit conditions.
“Right now every state seems to have a fiscal position with sufficient flexibility, that we view as able to get through a mild, shallow recession,” Geoffrey Buswick, government sector leader at S&P Global Ratings, said in an interview. “Typically some states within a longer recessionary cycle will face great credit pressures.”
While many economists anticipate any recession will be relatively shallow, there are some who are warning of a deeper drop. “There remains a very real risk that the US could be about to enter a prolonged recessionary period,” a report last month from Teneo Holdings said.
Sunny Skies
For the moment, states continue to enjoy an improved status on Wall Street. The Commonwealth of Massachusetts was upgraded from AA positive to AA+ stable by S&P on Friday. Its general-obligation debt is just one step below the highest level for the first time since 2008.
In February, Illinois improved to A- from BBB+ stable at S&P. And in March, the state was upgraded a level to A3 from Baa1 by Moody’s Investors Service and had its outlook changed to positive from stable by Fitch Ratings Ltd.
New Jersey was raised to A1 from A2 by Moody’s this month. Also in April the state went to A stable from A- positive at S&P and A+ stable from A positive at Fitch Ratings. The upgrades came after state officials in the last two fiscal years made full pension contribution payments for the first time in decades, reducing New Jersey’s unfunded retirement liability.
S&P anticipates a shallow recession, but says if a contraction were to linger some states could see credit impacts. Fitch also says that due to the aggressive Fed tightening to arrest inflation there will be a mild recession in 2023.
“If the downturn becomes much more severe and much deeper than we’re anticipating, that does raise risk and there’s the potential that there would be more negative rating action,” said Eric Kim, a Fitch analyst. “But that’s not what we’re anticipating. Our ratings build in an expectation of a moderate downturn. If things get much deeper and much weaker, there’s more risk there.”
–With assistance from Sue Lucas.
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