It's a very strange time, that's for sure. I think those here who are opining that the market has "priced it in," the rating agencies are somehow late to the party, and capital markets have the whole thing under control may be parroting a party line that doesn't apply in this instance.
The truth is that, between this and the latest intensification of the European debt crisis, funding markets are ceasing to function. It is a lot like 2008 in that you can basically be sure that, if the big shock comes, both you and all of your counterparties will incur losses, but nobody is sure how much and of what kind and who will get hurt the worst. In that atmosphere, funds are preparing for the wave of redemptions that will arrive, as usual, at precisely the moment when they have least idea of what their assets will be worth. BONY-Mellon has as much as come out and said that they don't want deposits. The 1W bill issued last week priced at zero yield. There is a profound effort to deleverage in preparation for a shock of unknowable proportions. To me, what we've seen happen recently with Treasury yields is more a matter of "in the land of the blind, the one-eyed man is king" rather than any sense in which the US's fiscal problems have been digested or accepted.
As for the downgrade specifically, I'll be interested to see what the ripple effect is in the agency RMBS market, and the knock-on effect in the residential market. The Treasury guarantee there has only ever been implicit, meaning that the logical effect would be for yield spreads there to rise. In a reasonable world, the falling rates at the long end combined with the higher spreads demanded by investors would cause new issuance in this market to drop, hurting RE prices in the process, but then again the Treasury has persisted in doing things that make no economic sense from a market standpoint in order to prop up real estate, so who knows? They would probably continue issuing even if we reached the superlatively bizarre situation where the credit spread demanded on mortgages falls below that demanded on the passthroughs.
Anyway, everybody get your helmets. It could get a little rough here for a bit.