- Although S&P Global Economics projects a rising risk of recession and slowing economic growth, we don't expect there to be a direct impact to local government and state ratings in the short term. It now places the chance of recession at 40% to 50% over the next 12 months, up from 20% to 30% in the March 2022 forecast.
- Federal stimulus dollars received by governments in 2020, 2021, and for some, 2022, help to keep finances on track post-COVID and will also help maintain credit stability as many issuers will be able to use funds to continue undertaking projects even if budgets get tight.
- The health of the state sector and strong reserve levels continue to provide a solid foundation for local governments. However, as recessionary pressures pick up through the end of 2022, stress at the state level could be felt by local governments.
The strength of the economy, both national and local, is a critical part of S&P Global Ratings' criteria both for states and local governments. While economic shifts don't always have a direct impact on credit quality for these issuers, changes and trends over time can create pressure. On a quarterly basis, S&P Global Ratings publishes a U.S. economic forecast ("Economic Outlook U.S. Q3 2022: The Summer Of Our Discontent," June 27, 2022) and a summary of North American credit conditions ("Credit Conditions North America Q3 2022: Credit Headwinds Turn Stormy," June 28, 2022). This article adds details to some of the factors in those reports that have the greatest possibility of affecting state and local government ratings.
Local Governments Remain Stable, For Now
S&P Global Economics' most recent U.S. economic forecast projects reductions in key economic measures over the next 12 months. Following the recent 75 basis point Fed rate hike, our economists raised the likelihood of a recession to 40% to 50% over the next 12 months ("U.S. Business Cycle Barometer: The Party's Over," July 27, 2022), up from 35% to 45% just a month prior. Due in large part to federal stimulus received in 2020 and 2021, local government credit quality remains stable but weakening economic conditions--even without a technical recession--could contribute to more credit pressures for local governments. (For more details about the National Bureau of Economic Research [NBER] and recessions, please see "Economic Research: U.S. Recession--Are We There Yet?," Aug. 2, 2022.)
Given their dependence on property taxes, local governments benefit from growth in the tax base, and a hot housing market has delivered. Across the U.S., there has been extremely strong growth in the housing market and the S&P/Case-Shiller U.S. National Home Price Index reached a historic high of 20.4% in April 2022, more than five times the average of 4% in the past five years. However, as prices continue to rise and interest rates go up, housing affordability is less attainable for many Americans (see "The American Dream May No Longer Be In Reach," July 20, 2022). We don't anticipate any near-term effect on local government credit quality from these home price spikes but will be watching closely over time to see how governments and residents could be affected.
Although housing prices remain high, S&P Global Ratings believes the market is supported by several fundamental economic factors that are unlikely to end soon. The most significant of these is the demand-supply imbalance since there is a shortage of several million homes in the U.S. and the pace of building would have to increase substantially to meet demand in coming years. Given this, we expect continued price appreciation nationally, albeit at a more subdued pace, with declines only in certain regions. Even then, since economic softness generally takes longer to run through the tax assessment and collection process, local governments should have time to adjust if there is a downturn; for example, during the Great Recession there were increases in property tax delinquencies but the effect on ratings was limited.
States Are Generally Healthy
States came out of the pandemic with higher rainy day reserves than they went in, so should be prepared if another recession occurs in the near term. Most states have adopted fiscal 2023 budgets that are structurally balanced, although there is potential for an economic contraction that could lead some to revisit their fiscal year revenue projections and cut expenditures.
Federal support and related spending remain key focus areas for states. Spending one-time revenue from the American Rescue Plan Act and the Infrastructure Investment and Jobs Act on one-time expenses could be a stabilizing factor for credit, but new programs without recurring revenues may pressure out-year budgets and credit stability, particularly in a recessionary environment. All of this could be enhanced by the double-edged sword of inflation since it can help some revenues remain on-budget but also leads to higher expenditures.
Medicaid remains the largest annual outlay from the federal government to the states, and changes in this disbursement are likely coming in the next six to nine months since extra COVID-related Medicaid funds will run out by Sept. 30, 2022, unless the program is extended. This could lead to budget challenges right when economic conditions are also worsening. Federal law prohibited removing Medicaid coverage for approximately 16.1 million enrolled individuals (or 22.5% above February 2020 enrollment) since the onset of the national health emergency, which is currently extended through mid-October 2022. Once the emergency ends, states will largely be responsible for redetermining eligibility and unwinding their Medicaid rolls, which could lead to significant variations in spending across states.
Most states use economic projections in determining budgets. Current projections, for the most part, all agree that economic conditions will remain muted compared to calendar 2021 highs and that the growth rate will slow or perhaps even stall. Even with slower growth projections state revenue forecasts still show increases; we consider this reasonable given the economic climate. However, even with credit pressures that arise over the next year, we believe that strong rainy-day balances and revenue projections that reflect a slowing economy still allow continued stability in the sector.
The Labor Market And Inflation Continue To Exert The Most Pressure
Two sectors of the economy that could influence the credit stability of state and local governments the most are the labor market and inflation. These charts from our most recent U.S. economic forecast indicate some of the challenges the economy faces: not enough workers, and less buying power even with higher wages.
While most governments have been managing well through a challenging post-pandemic labor market, gaps in the workforce, such as shown in chart 3, can slow economic growth over time. This influences all major tax sources, particularly income and sales taxes. To date, only 56% of state and local jobs cut at the start of the pandemic have been recovered, underscoring the slow return of jobs in the government space.
Low unemployment generally bodes well for sales tax collections, but competition for workers is pushing wages up and exacerbating inflation. More sales translate to higher sales taxes but high inflation means less buying power, which can affect consumer spending levels.
Key Credit Factors To Consider
There are numerous key economic factors we consider important to state and local government credit health; some are macro factors that S&P Global Ratings defines as Key Risks and assigns risk levels. Others are offshoots of the economic factors that particularly affect governments although the effects are felt broadly across public finance in general. These factors include:
Comparing The Regions: Gross State Product, Unemployment, And Inflation
There are few significant outliers when comparing projections for these three key data points. However, the confluence of weaker--or stronger--projections could affect the economic stability in some regions. Of the nine U.S. Census regions, only one, West South Central, has two of the weakest projections, and only one, Pacific, has two of the strongest.
For additional regional data, please see the table below.
|Regional Baseline Credit Driver Forecasts|
|% change unless otherwise indicated|
|Consumer Price Index||1.6||1.4||4.0||7.9||3.5|
|Home price, existing median||4.6||7.9||17.1||15.6||8.6|
|Home price, existing median ($)||353,847||381,769||446,930||516,846||561,328|
|Housing starts, total private||(4.2)||(0.8)||8.1||9.8||(11.2)|
|Housing starts, total private (000)||31||31||33||36||32|
|Real GSP growth||2.1||(4.1)||5.8||2.0||0.8|
|Real retail sales||0.9||2.0||8.4||(0.0)||(1.4)|
|Consumer Price Index||1.6||1.2||3.9||7.6||3.5|
|Home price, existing median||4.2||7.5||15.1||15.1||8.4|
|Home price, existing median ($)||303,581||326,362||375,791||432,385||468,661|
|Housing starts, total private||6.0||(1.9)||26.9||(3.3)||(18.5)|
|Housing starts, total private (000)||84||82||104||101||82|
|Real GSP growth||2.2||(4.8)||4.9||1.2||1.1|
|Real retail sales||1.3||2.5||12.1||0.4||(2.4)|
|Consumer Price Index||1.5||1.1||5.1||7.8||3.3|
|Home price, existing median||5.1||8.0||17.6||20.8||9.6|
|Home price, existing median ($)||246,033||265,714||312,397||377,518||413,765|
|Housing starts, total private||6.6||6.2||16.1||2.5||(10.7)|
|Housing starts, total private (000)||373||397||460||472||421|
|Real GSP growth||2.3||(3.1)||5.5||1.6||1.4|
|Real retail sales||2.0||1.3||12.3||1.4||(1.8)|
|East South Central|
|Consumer Price Index||1.3||0.9||5.1||7.7||3.2|
|Home price, existing median||6.0||8.5||17.4||19.4||8.1|
|Home price, existing median ($)||165,049||179,016||210,213||250,965||271,278|
|Housing starts, total private||9.3||10.5||15.5||(7.1)||(7.9)|
|Housing starts, total private (000)||77||85||98||91||84|
|Real GSP growth||1.6||(3.3)||6.0||1.1||0.9|
|Real retail sales||0.9||4.4||14.8||0.9||(3.9)|
|East North Central|
|Consumer Price Index||1.5||1.0||5.2||7.7||3.2|
|Home price, existing median||5.1||7.6||14.3||15.2||7.8|
|Home price, existing median ($)||184,157||198,107||226,353||260,741||281,119|
|Housing starts, total private||(2.3)||14.0||9.0||0.1||(1.7)|
|Housing starts, total private (000)||96||109||119||120||117|
|Real GSP growth||0.8||(4.1)||5.2||0.8||1.2|
|Real retail sales||1.0||2.8||13.9||0.3||(2.3)|
|West North Central|
|Consumer Price Index||1.4||0.9||4.9||7.7||3.1|
|Home price, existing median||5.0||7.1||13.9||15.0||8.2|
|Home price, existing median ($)||191,467||205,149||233,628||268,689||290,801|
|Housing starts, total private||1.9||14.6||17.2||(7.1)||(9.7)|
|Housing starts, total private (000)||73||84||98||91||82|
|Real GSP growth||0.8||(2.7)||5.1||0.1||1.3|
|Real retail sales||1.4||2.7||14.0||2.2||(3.1)|
|West South Central|
|Consumer Price Index||1.4||0.7||5.1||8.0||3.4|
|Home price, existing median||4.6||6.4||16.1||17.8||8.6|
|Home price, existing median ($)||177,804||189,142||219,587||258,698||280,835|
|Housing starts, total private||12.7||10.6||11.1||0.2||(7.9)|
|Housing starts, total private (000)||236||261||290||291||268|
|Real GSP growth||2.6||(3.3)||5.0||2.2||1.9|
|Real retail sales||(0.5)||(0.7)||14.2||2.6||(1.8)|
|Consumer Price Index||2.5||1.0||3.9||7.6||3.3|
|Home price, existing median||6.8||9.7||21.8||21.0||9.7|
|Home price, existing median ($)||297,920||326,748||398,034||481,683||528,357|
|Housing starts, total private||(1.6)||17.8||19.5||(3.4)||(11.4)|
|Housing starts, total private (000)||153||180||215||208||184|
|Real GSP growth||3.7||(2.5)||5.6||1.4||1.9|
|Real retail sales||(0.4)||0.3||16.3||3.3||(1.4)|
|Consumer Price Index||2.7||2.0||4.8||7.6||3.4|
|Home price, existing median||4.3||7.9||18.8||19.1||9.8|
|Home price, existing median ($)||523,525||564,893||671,094||799,286||877,421|
|Housing starts, total private||(7.0)||(1.1)||12.0||0.6||1.2|
|Housing starts, total private (000)||168||166||186||187||189|
|Real GSP growth||3.4||(2.7)||7.3||2.0||1.1|
|Real retail sales||2.6||1.3||15.1||1.5||(1.9)|
|Source: S&P Global Market Intelligence|
- Pension Brief: 2022’s Down Markets Reverse 2021’s Unprecedented Gains For U.S. Public Pension Plans, June 8, 2022
This report does not constitute a rating action.
|Primary Credit Analyst:||Jane H Ridley, Centennial + 1 (303) 721 4487;|
|Secondary Contacts:||Geoffrey E Buswick, Boston + 1 (617) 530 8311;|
|Robin L Prunty, New York + 1 (212) 438 2081;|
|Research Contributors:||Vikram Sawant, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Mumbai|
|Adriana Artola, San Francisco + 415-371-5057;|
|Matthew T Martin, New York + 1 (212) 438 8227;|
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