Higher interest rates, inflation and slower economic growth could create headwinds for the U.S. public finance sector, S&P Global Ratings said in a report Friday.
Continuing credit strength has led to growing revenues and expanded reserves, S&P analysts led by Robin Prunty wrote in the report.
"However, if local or macroeconomic conditions prevent revenues from keeping pace with expenditure growth, management teams could be pressured to balance budgets while still addressing persistent issues requiring longer-term solutions," Prunty said.
While federal aid has allowed municipalities to avoid issuing debt in a higher interest rate environment, S&P expects this flexibility to diminish this year.
"If interest rates are lowered as expected in 2024, debt issuance may accelerate," Prunty added.
Outlooks are stable across sectors, with the exceptions of not-for-profit health care, public power and electric cooperatives and mass transit, according to S&P.
S&P has a negative outlook for the mass transit sector, with many agencies across the US running up against budget deficits. In not-for-profit health care, S&P sees a constrained operating environment in 2024 as hospitals continue to face staffing shortages and high labor costs.
"We're seeing more budget officials grapple with budget shortfalls, many for the first time in office. So, gone are the heydays of surpluses and revenue windfalls," said Dora Lee, director of research at Belle Haven Investments. "The budget conversations are gonna be a lot tougher."
The possible headwinds come as municipal-bond investors begin rushing back into the market. For the fifth straight week,
After dumping more than $120 billion over the last two years, skittish investors have returned to the market in pursuit of higher yields, ahead of interest-rate cuts from the US central bank.
Debt issuance could also start to tick up this year.
"Federal stimulus funds and strong reserves have provided flexibility for many governments and not-for-profit entities to avoid issuing debt in a higher interest rate environment, but we expect this flexibility will be diminished in 2024," S&P said. "If interest rates are lowered as expected in 2024, debt issuance may accelerate."
Lee said that issuers have delayed projects for too long and that they can only put them off for so much longer.
"We expect to see more issuers get off the sidelines and tap the capital markets to help with their various infrastructure costs," she said.
