Moody's Investors Service has revised its outlook for the U.S. states sector to stable from negative, while the outlook for local governments remains negative.

The outlooks and the reasons for them were described in reports released Tuesday. The outlooks convey Moody's expectations for the sectors' fundamental credit conditions over the next 12 to 18 months.

The state sector outlook revision reflects several trends. Increased economic stability is being shown by key indicators, with the housing and labor markets improving and the stock market performing well. There is also more certainty about the impact of federal fiscal policy, Moody's said.

Additionally, revenue growth in many states that has exceeded expectations, and states are continuing to build their reserves.

"While economic and financial recovery has been uneven and occasionally unsteady, we expect most states will manage their remaining challenges through the tight budgeting and fiscal restraint that became typical during the recession," Moody's vice presidents Baye Larsen and Nicole Johnson wrote in the report on the state sector.

Prior to the revision, the state sector outlet had been negative for more than five years. Credit quality among individual states remains high, with 30 states holding ratings in the two highest categories, Moody's said.

Several factors present risks to the stable outlook, the ratings agency said. Employment levels remain below their pre-recession peak, there has been a delay in full fiscal recovery in some states, federal deficit reduction could create economic drag, and the budgetary pressure of pension contributions will continue to squeeze some states' finances.

In the report maintaining the negative rating for local governments, analyst Dan Seymour wrote that local governments benefit less directly from the main reasons for improvement in states' credit conditions.

States' overall economic trends can mask weaknesses in sub-state areas. Also, state aid to local governments hasn't fully recovered to pre-recession levels, and local governments have less flexibility to handle financial pressures like those involving pensions and health care for retirees, the ratings agency said.

Additionally, state revenues have recovered more sharply than local revenues because states have benefited more from the thriving stock market and payroll growth. Moody's doesn't expect local governments to see significant revenue increases from the housing recovery in the short run because property tax revenue increases lag growth in real estate market value.

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