As Wall Street took another plunge, investors on Monday piled into the US Treasury market, shrugging off for now the Standard & Poor's downgrade of US debt . For many, a shelter from the storm raging in risky assets was the bigger concern.
"It is the irony of the downgrade," says Lou Crandall at Wrightson Icap. "What do you do if the US is downgraded? The answer is, buy more Treasuries. The reality is there is no alternative to the dollar as a reserve currency right now."
Prices on US government bonds surged as investors and traders fled risk. By midday in New York, the S&P 500 stock index had fallen 3.8 per cent to its lowest in 10 months. At the same time, two-year US Treasury yields hit an all-time low of 0.24 per cent and the 10-year yield fell to 2.36 per cent, a level not seen since the height of the crisis in 2008.
Investors are increasingly worried about the risks to global growth and the potential for a meltdown in the eurozone, where the European Central Bank is struggling to restore confidence. The automatic response has been to buy US Treasury debt.
Indeed, relative to the debt of eurozone nations, the creditworthiness of the US still looks a good prospect.
However, the S&P downgrade added to the anxiety in financial markets because it drew attention to America's weakening economic fundamentals as well as the political opposition to measures previously used by lawmakers to revive flagging growth, such as a big economic stimulus. That was bad for equities.
"The downgrade is another mini-blow to a fragile economic and financial situation," says Ethan Harris, North American economist at Bank of America Merrill Lynch.
Few investors had anticipated a quiet start to the week. But the scale of stock market selling and buying of Treasuries exceeded some expectations. "I was hoping for less of a market reaction than we're seeing," says Steve Lear, deputy chief investment officer for JPMorgan Asset Management's global fixed income group. "The market is grappling with the global economic situation, and the downgrade and the eurozone's problems are manifestations of that."
Mr Crandall argues that the impact on wider business and consumer confidence could make the impact of the downgrade long-lasting. "Regardless of whether there is any new information in the S&P downgrade, regardless of whether it's going to have much practical impact in terms of forcing selling by investors, when you get this kind of prominent focal point for investor anxiety and business confidence, it might end up having an effect on the economic landscape," he says.
"There are major tail risks [from the downgrade]," says Mr Harris. "The US and global economy are in feeble rehab recovery and a trio of shocks has hit the economy: surging oil prices, the Japan disruption and the debt crises in Europe and the US. We cannot rule out that this is the straw that breaks the camel's back."
The S&P's sell-off, and stock market falls elsewhere that took some indices into "bear market" territory, draws more attention to the theoretical bargains that can be snapped up in the equity market.
In valuation terms - both in terms of historical price to earnings ratios and the yields on stocks relative to those on government bonds - equities appear to be good value. Few investors, though, are willing to jump in, especially given the threat to confidence. Instead, the consensus is that Treasuries could rally further, a pattern that has repeated itself several times in the last three years of the financial crisis.
"In a world where growth and inflation are going to be low, Treasury yields are also going to be low," says Paul Dales, economist at Capital Economics.
"Despite the downgrade, the fact is that US Treasuries are the world's safe haven. No other government bond market is nearly as deep or as liquid. Where else would you go?"
With investors shunning risk, all eyes are again on what the Federal Reserve will do to ease the availability of credit to the US economy. The Fed's policymaking meeting takes place on Tuesday.
The extent of moves in the markets may be a factor. For example, Morgan Stanley says the combination of sharp moves in Treasury rates, spreads, equities and the dollar is indicating stress.
"Market weakness and uncertainty from S&P's downgrade on US Treasuries spurred a tightening in our financial conditions index to levels that prompted [quantitative easing] a year ago," says Jim Caron at Morgan Stanley. "We are in a 'zone of action' for the Fed, and tomorrow's Fed meeting could be the trigger."
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