The fiscal health of U.S. states is in the spotlight after Moody’s Ratings lowered the United States’ credit score.
In a May 16 announcement, the agency downgraded the United States’ long-term credit rating by one notch, citing the federal government’s deteriorating fiscal outlook.
Moody’s decision cast a shadow over the financial markets to kick off the trading week, sending yields on U.S. government debt higher.
But while market watchers monitor the potential fallout on Wall Street, state fiscal conditions have become the focus of attention.
For now, states might be largely unscathed by Moody’s action. A dozen states, including Florida, North Carolina, Tennessee, and Texas, maintain perfect credit scores from various ratings agencies.
“Florida’s ‘AAA’ IDR and full faith and credit ratings recognize the state’s history of sound financial management practices, high gap-closing capacity and reserves, and low long-term liability burden,” Fitch analysts said in the report. “The state’s long-term economic and revenue growth prospects should be in line with or above national economic performance.”
S&P Global Ratings assigned North Carolina a triple-A score, citing the Tar Heel State’s economic growth, financial management, and “commitment to maintaining balanced biennial budgets.”
Tennessee has a triple-A rating from the so-called “Holy Trinity” of the major credit ratings agencies.
The “Fiscal Survey of States” study determined that general fund spending is expected to decrease by 0.3 percent this year, and general fund revenues are projected to increase by nearly 2 percent.
“The median rainy day fund balance as a percentage of general fund expenditures has grown every year since the aftermath of the Great Recession in fiscal 2011, and states are expecting to continue this streak, with a median balance projected at 14.4 percent at the end of fiscal 2025,” the report stated.
The Pew Charitable Trusts has raised alarm bells about growing trends of tapping into reserves, especially as uncertainty surrounding federal funding intensifies.
“And with recession risks rising, states may also need reserves for their traditional purpose of helping to close shortfalls during economic downturns.”
By comparison, Connecticut, Illinois, and New Jersey have the nation’s lowest credit ratings amid challenges regarding budget deficits, high pension liabilities, and struggling economies.
However, analysts have become more optimistic about these states’ financial outlook in recent years.
Watching the Municipal Bond Market
Still, despite the solid fiscal performance by many U.S. states, market analysts say volatility in the Treasury market is likely to be felt in the municipal bond market—a corner of the financial markets in which state and local governments issue debt. This was observed in April when tariff-driven turbulence triggered vast movements.“The municipal bond market faced significant volatility in April, driven by spillovers from a turbulent Treasury market,” Lawrence Gillum, chief fixed income strategist at LPL Financial, said in an email to The Epoch Times.
A significant issue facing the municipal bond market is supply outpacing demand, according to Gillum. In the first quarter of 2025, total state and local government debt issuance was $182 billion, an 18 percent increase over the previous year.
“An increase in supply by the magnitude that we’ve seen over the past 16 months can be a sizable headwind if demand doesn’t increase commensurately, which unfortunately it hasn’t,” he said.
Municipal bond exchange-traded funds (ETFs) weakened slightly during the May 19 trading session. The iShares National Muni Bond ETF and iShares High Yield Muni Income Active ETF dipped by about 0.1 percent.
The long-term effects of Moody’s downgrade on the U.S. bond market are uncertain. Because Fitch and S&P had already downgraded the United States below triple-A, the impact on the financial markets may be less severe.
“The Moody’s downgrade wasn’t dramatic news (S&P and Fitch downgraded U.S. debt years ago), but it is pushing the 10-year yield higher and that’s weighing on [stock] futures,” Tom Essaye, president and founder of the Sevens Research Report, said in an email to The Epoch Times.
Long-term interest rates have risen, with the 30-year yield briefly topping 5 percent for the first time since the start of the year. The benchmark 10-year yield reached 4.5 percent.
Treasury Secretary Scott Bessent dismissed the Moody’s one-notch downgrade as a “lagging indicator” caused by the previous administration.
Bessent has stated that the Trump administration will bolster the federal government’s finances by cutting spending and deregulating the economy, which he said will help lower interest rates.
“Why I am sitting here is to take away the credit risk of the U.S. government. Then I think rates will naturally come down,” Bessent said at a May 5 Milken Institute event.
