Treasurys rallied on the first day of trading following the downgrade of the U.S. credit rating by Standard & Poor’s.
This immediate surge in Treasurys confounded the expectations of some that a downgrade would force institutional investors to sell the bonds.
Some of the biggest holders of Treasurys, including mutual funds and insurance companies, are subject to legal limitations about the kind of assets they can hold. Generally, they are required to hold only high-quality portfolios with highly rated debt securities.
But, as I have explained earlier, these limitations do not require a sell-off of Treasurys. Insurance companies are often given carte blanche when it comes to government bonds—they are considered risk-free by regulations regardless of the rating. Money market funds are allowed to hold Treasurys even after several notches of downgrade.
In any case, almost no one is actually forced into a fire-sale situation—even if Treasurys somehow became ineligible securities.
They are almost always permitted to keep holding ineligible assets if they believe the market has become disorderly.
Don’t be surprised that Treasurys are rallying. We told you this would probably happen.
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