For the record, I still believe that there will not be a breach of the debt ceiling and no overt default for the US. Things will be worked out in the nick of time, like they always are.
However, the media is full of articles wondering about what ‘investors’ might do in response to a US default and/or credit downgrade. What will happen to Treasury prices? Will they go down as investors dump them en masse in response to a credit downgrade forcing interest rates to climb?
It’s a big question and the most likely answer is “No, not really”. Partly because these so-called investors have been well-conditioned to believe that another bailout is always around the corner, but mainly because they have nowhere to go.
The big money is trapped.
For example, imagine that you are in charge of a money market fund with $100 billion under management and your job is to both cover your expenses and assure a return for your depositors and you are heavily invested in US Treasurys. Or imagine that you are in charge of a public pension with $200 billion under management with the same basic concerns of managing expenses and delivering returns and a heavy exposure to US Treasurys but with a much longer time horizon.
In either case, in light of the possibility of a US default what would you do? Where would you put your money right now if you were suddenly of the mind that the $50 billion you had in Treasurys should be placed somewhere else? In reality there are not that many places to quickly move such large sums of money. Further, there are fiduciary restrictions that limit investment options to regions, investment types and ratings grades.
So let’s imagine that you have to make very large and important financial decisions and that you have to put your money to work; it’s an actual fiduciary requirement of yours. An excessive amount of cash is not an option and neither are hard assets such as land, gold or silver. Where would you put it? What realistic options exist?
The Treasury market is the largest and most liquid in the world, by far. For many big money funds there really aren’t any realistic options other than the Treasury market, and this present reality will limit the market reaction to any downgrade.
