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An ugly day The world awoke this morning to a new world. And so far, it's not pretty.

Global markets are sinking as leaders and policy makers around the world try to calm the frayed nerves of investors, who have ignored last night's feel-good promise by the G7 to do what it takes to head off more trauma. As The Globe and Mail's Shawn McCarthy writes, it's a crisis of confidence sweeping through the markets.

Coupled with the downgrade is the ongoing debt crisis in Europe, where finance officials actually did more than just talk today and intervened in markets to buy Spanish and Italian bonds.

It's the first chance investors have had to react to the S&P downgrade of the land of the free, home of the brave, and the heart of capitalism, though Friday night's move by the credit rating agency should not have come as a surprise.

"Putting the usual 'shoot the messenger' knee jerk reactions of U.S. policy makers to one side for one moment, the general feeling [is that it was] probably long overdue, however the big surprise was the fact that S&P kept the U.S. on negative watch, suggesting that another downgrade could happen in the next 18 months," said CMC Markets analyst Michael Hewson.

"S&P cited the recent debt ceiling shenanigans as part of its reasoning as well as the low level if spending cuts. Friday’s action will now inevitably shift the focus onto Fitch and Moody’s ratings."

As The Globe and Mail's Omar El Akkad reports this morning, the reaction in the markets so far has been fierce.

Both Tokyo's benchmark Nikkei and Hong Kong's Hang Seng shed 2.2 per cent. In Europe, London's FTSE 100, Germany's DAX and the Paris CAC 40 were down by between about 3 per cent and 4 per cent, and in North America, the Dow Jones industrial average , theS&P 500 and the S&P/TSX composite were down sharply.

Oil fell and gold surged.

"So far equities rather than Treasuries are paying the price," said Sal Guatieri of BMO Nesbitt Burns.

What's next? How bad will it get, and is the United States really out of favour for long?

Avery Shenfeld, the chief economist at CIBC World Markets, believes the impact on U.S. borrowing costs will be minimal, and that "this will be old news" by Friday, with the focus back to the sputtering U.S. recovery.

"Indeed, the irony is that Treasury yields are lower today on a flight to safety bid out of equities worldwide," Mr. Shenfeld said in a research note.

"Canada saw no change in spreads vs. the U.S. when it was downgraded by Moody’s in 1995 ... The greater risk is that the downgrade is perceived as putting the U.S. into even more of a fiscal straightjacket than the Republican Tea Partiers are advocating, leaving less room for new stimulus should growth falter. We still see growth risks as the major concern for equities in the U.S. (although government debt is a critical issue in parts of the euro zone where borrowing costs have spiked higher)."

BMO's Mr. Guatieri pointed to the rally in Treasuries as evidence that they are still a safe haven.

"Despite losing its mint rating, the U.S. is extremely unlikely to default, given its enormous wealth and potential to raise tax revenue," he sad. "The deep, liquid Treasury pool will still be the one investors dive into when the financial climate gets sticky. Most money-market funds won’t be forced to sell their new non-AAA-rated Treasury holdings, and banks and insurers are unlikely to be forced to hold more capital against their Treasury holdings."

Derek Holt and Karen Cordes Woods of Scotia Capital aren't so sure.

"Are there knock-on to effects to follow?" Mr. Holt said.

"Another wave of deleveraging could well be one of them," Mr. Holt and Ms. Woods said in a research report.

"What those who are dismissing the punitive role of a downgrade are forgetting that Treasuries are at the root of many leveraged transactions in the global financial system. I'm concerned about the deleveraging consequences (i.e: the knock-on effects on leveraged transactions) that could compound challenges facing the risk trade to start the week."

ECB pushes down bond yields The European Central Bank made good on its promise to support the debt of Italy and Spain, the two latest euro zone countries in the eye of the storm, in a bid to halt the virus in its tracks.

"The impact has been substantial with Spanish and Italian yields down across the curve but especially in the short end and with the most buying in the 5-year segment where Italian yields have plunged 86 basis points," said Scotia Capital's Mr. Holt and Ms. Woods.

"Two-year Italian yields are now down 71 basis points to 3.8 per cent while 10-year yields are down 73 basis points to 5.35 per cent. Spanish bonds have rallied even further with two-year yields down more than 1 per cent to 3.34 per cent while 10-year yields have fallen almost 80 basis points to 5.25 per cent. The ECB also increased pressure on euro area governments to pass the changes agreed upon at the July 21 EU summit which will augment the powers of the [bailout fund], allowing it to buy bonds on the secondary market."

But that move carries its own risks, noted CMC's Mr. Hewson.

"This could well create problems going forward as the ECB ups its exposure to peripheral debt, thus exposing any new potentially expanded [bailout fund] to more liabilities, which in turn could then see France’s finances come under close scrutiny, as their contribution to the fund would then become much larger."

What should investors do? Stay calm and don't fool around with your long-term plan. Personal Finance writer Rob Carrick weighs in today with do's and don'ts amid the market chaos.

RBC downbeat on airlines RBC Dominion Securities is taking a dimmer view of Canada' two main airlines, cutting its price targets on shares of Air Canada and WestJet after their earnings last week.

Analyst Walter Spracklin cut his price target on Air Canada to $2 from $2.50, and on WestJet to $14 from $16. He held his rating on Air Canada at "sector perform," but trimmed his WestJet rating to "sector perform" from "outperform."

In Personal Finance today Many Canadians owe more debt than their income. Avoid falling into that trap.

Ideas for projects that can be completed more efficiently in the summer and may save you time and money along the way.

From today's Report on Business

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