The part that I am thinking about is pension funds. They have to have an average weighted rating, and the usual pension portfolio holds some amount of long-dated treasuries to duration-match their portfolio with the duration of their obligation. So, when treasuries get downgraded to AA, the average weighting of the portfolio will thus fall. Pensions will then try and get rid of them and exchange them for AAA bonds that will push them back up to an adequate rating.
Two questions then arise:
1) How illiquid would the market become when all pension funds start dumping treasuries?
2) Are there enough AAA corporates /agencies/munis to cover the new increased demand?
The effects would then be a rising US treasury yield and a falling AAA everything else yield. Maybe play the spread?
Let me know your thoughts.
**UPDATE**
The answer to this question is that pension funds usually use and average of the 3 credit rating agencies as a rating for holding in the portfolio. Thus, this situation would only occur on the second rating agency downgrading the US (like that will ever happen), or if S&P decides to move US below A rating... which isn't going to happen either. Thus, it looks like we're safe for now.
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