After Fitch Ratings put the U.S. government’s debt on watch for a negative downgrade Wednesday, Fitch analysts have been busy working out the implications for the $4 trillion muni bond market.
While the credit-rating firm believes Republicans and Democrats will reach a federal spending compromise before any Treasury bills default, Fitch analysts are wary of how a spending deal could hit the revenues of state and local governments.
“We’re certainly watching very closely,” said Doug Offerman, a senior director at the firm’s public finance states group. Local governments rely directly on federal funding for healthcare, education and transportation. With federal spending amounting to a third of gross national product, any big change will affect local economies. “It’s a big footprint,” Offerman said.
Muni bonds make up less than 10% of the U.S. fixed-income market, but individual investors hold a large share of the sector’s thousands of different debt issues. Muni bond prices haven’t moved much in recent days.
Since the federal government bumped into its debt ceiling in January, the Treasury has been spending down its cash and juggling payments. Without a deal to raise the debt ceiling, It could exhaust those resources as early as June.
Missing any payments on Treasury bills would imperil the U.S. government’s AAA rating, said Fitch in its Wednesday announcement.
“The brinkmanship over the debt ceiling, failure of the U.S. authorities to meaningfully tackle medium-term fiscal challenges that will lead to rising budget deficits and a growing debt burden signal downside risks to U.S. creditworthiness,” said the Fitch release.
Thursday,
Morningstar
‘s DBRS rating unit also put its U.S. debt rating under review. S&P Global Ratings told Barron’s it had taken no action yet.
A small number of local bond issuers might be immediately affected by any federal defaults, said Fitch’s Offerman. Those would include municipal housing authorities with bonds secured by the federal agency mortgage-backed securities.
If Washington makes a substantial change to federal spending levels, that would have longer term implications for a broader range of muni bond issuers, he said.
Hospital systems and higher education rely on federal dollars. But the vast majority of state and local debt issuers have tremendous flexibility to adjust for any cuts in federal spending, Offerman said. Many of those governments have cash cushions plumped by the past decade’s expansion. They also can raise taxes from a variety of sources, and cut their own spending.
Offerman reiterates that Fitch isn’t currently expecting any Treasury defaults—but his muni bond analysts will be watching Washington’s decisions in the coming weeks to see where local impacts might be felt.
Write to Bill Alpert at william.alpert@barrons.com
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