Fitch cut the US rating downgrade because of an “expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to 'AA' and 'AAA-rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions." Such a decision would put pressure on any country's government bonds. However, it did not trouble US Treasuries; why?
The answer to that question relates to the fact that US Treasuries are notoriously regarded to be a safe haven. A deterioration of the US economy implies higher risks in the corporate space. Therefore, investors would sell risky assets and flee to safety. Guess where they would find safety? In US Treasuries!
Although Fitch’s downgrade differs in many ways from the 2011 S&P downgrade, it makes sense to revisit this event to understand what has happened in the past.
On August the 5th, 2011, a few days after Congress agreed to increase the US debt ceiling solving a debacle going on for months, S&P downgraded the US government rating from AAA to AA+. US Treasuries rallied across maturities, with 10-year dropping by 38bps by the end of August.
Back then, market participants understood the considerable problem the market would run into if another rating agency were to cut the US rating, pushing US debt into AA+ territory rather than AAA. That’s why since then, contracts such as repurchase agreements, loans, and derivatives have been written to include “debt backed by the US government.” This is why yesterday’s Fitch credit downgrade will not force the unwinding of such contracts, removing a lot of pressure that otherwise might have been applied to US Treasuries.
The most significant risk the market faces in the upcoming weeks is the reconsideration of credit risk in financial markets. If the US economy is deteriorating, that's bad news for the US corporate space. Therefore, some investors might see scope to sell risky assets to flee to safety, which they can find where? In US Treasuries!