Moody's Investors Service Wednesday cut New Jersey's credit rating one notch to Aa3 from Aa2, citing the state's weakening financial position.
The state's economy is unlikely to recover "in the medium term due to rapidly rising fixed costs, relatively slow economic recovery, and a lack of (a) specified plan to rebuild fund balances," Moody's said in a statement.
Moody's also highlighted the problem that New Jersey has a $31 billion shortfall in its pension liability.
"Pension and other post-employment benefit liabilities will continue to grow rapidly, further pressuring the already high-debt state," the statement said.
Investors in the $2.9 trillion U.S. municipal bond market have worried for a year that the recession would prompt numerous downgrades and even defaults, though historically they have been rare.
Republican Governor Chris Christie has made national headlines for his fiscally conservative policies though he also has been criticized for skipping last year's pension fund contribution.
New Jersey's bonds were unchanged after the Moody's downgrade, mainly because traders had anticipated the action.
"New Jersey being downgraded is completely factored in to the market and based on the stable outlook that you see, there's perhaps some upside to the trading value of the bonds," said Michael Pietronico, chief investment officer of Miller Tabak Asset Management in New York.
Whether New Jersey's debt commands higher prices in coming days depends partly on its borrowing plans. "That remains to be seen but a lot of (any rise in prices) will be driven by supply," Pietronico said.
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