The implication of a rating downgrade is for interest rates on the rated debt to rise as compensation for the increased risk of holding said debt.
Many of the bond investment funds are required to only invest in AAA rated securities. What will be the response of these funds?
What will be the response of the rest of the world?
What will be the response of the speculators in the US Treasury market?
Yields started to rise on Friday, as the stock market was trying to find a bottom. Friday was the first day in several that had buying volume greater than selling volume. This was as the treasury market sold off all day. As I've said before, the US Treasury market, as represented by the ETF: TLT, is my tell for the future direction of the stock indexes. When TLT goes up, stocks go down, and visa versa. It seems to be a good indicator in short and medium time frames, from hours to days.
That is as long as Treasuries are a place of refuge in a world of uncertainty. What will happen if they lose some of their "safe haven" luster? Rising interest rates are generally bad for the stock market. But if bonds start to fall, where will the money that is fleeing bonds go? To dollars? If the dollar gets stronger, that usually means interest rates go down since the risk of inflation declines...
I usually put more faith in just trying to make a good trade than trying to predict markets and then placing a bet. I am short the U.S. Treasurys using the inverse bond fund TBT. And simply because bonds are a "back and fill" market, meaning they tend to not have strong directional short term trades for very long. And the UST is way to high too fast. I feel that the fear of the last week is overdone. The world is not coming to and end. At least not next week. So I expect some sort of stock rally, and some sort of treasury selloff. Both will happen because of the lopsided trades that were probably put on in the last couple weeks. The chart of TBT shows a large volume "reversal" day last friday. We will see if this "reversal pattern" fares any better than the one in the stock indexes last week!!
Remember: always limit your risk!