US States Likely to Defy US Downgrade to Keep Top Credit Ratings
Still, the impact will likely be felt in some areas of the muni market — just as it was with Fitch’s downgrade. After its move, Fitch cut billions of dollars worth of municipal debt that was linked to the country’s rating, such as pre-refunded municipal bonds with repayments that are wholly dependent on US government and agency obligations held in escrow.
Credits like DC and some housing transactions do have connections with the federal government, according to the JPMorgan analysts, who once again cited the Moody’s report from 2023.
After its revision in 2023, Moody’s also changed the outlook on its Aaa rating of the Smithsonian Institution to negative from stable. The move reflected “the material funding and governance linkages between the Smithsonian and the United States government.”
More Volatility
The muni market, in addition to corporates across America, could be impacted in other ways by the move higher in US Treasury yields. State and local debt tends to take its cues from that market.
Municipal housing bonds that are mainly secured by mortgage-backed securities issued by Ginnie Mae, Fannie Mae or Freddie Mac saw their ratings cut at the time of Fitch’s downgrade. Prices of MBS fall when interest rates fluctuate, and any further moves would add to recent gyrations triggered by tariffs that proved painful for the bonds.
“Volatility remains elevated, particularly with long rates reaching relatively high levels recently,” said Neil Aggarwal, a portfolio manager at Reams Asset Management. “So fixed-income investors I think do have some concerns regarding growth and liquidity already.”
Volatility increased after Fitch’s downgrade in 2023, hurting returns for some investors relative to Treasuries. But on a bigger scale, Aggarwal said the overall impact for MBS would likely be contained. Major holders of the bonds don’t tend to be overly sensitive to changes in government ratings, barring a bigger or unexpected downgrade.
“Given it was a half-step downgrade and other rating agencies had already gone first, the direct impact is likely to be less than rate volatility impact,” said Ken Shinoda, a portfolio manager at DoubleLine Capital.
Following its downgrade of the US, Fitch also cut the ratings of Fannie Mae and Freddie Mac, which remained in government conservatorship after being taken over during the 2008 global financial crisis. That in turn caused credit ratings for over 400 securities tied to the two entities to be lowered.
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