Standard & Poors Cuts USA credit rating from AAA to AA+...Federal Reserve on the defensive...next steps?

It was the biggest open secret in Washington DC the failure to satisfactorily tackle the USA debt ceiling debate was going to trigger an urgent ratings review which had been signaled by S&P earlier this year.

It's now happened. S&P announced the downgrade on Friday night around 8.30pm EST, Saturday morning 8.30am Asia. It was a monumental moment in the history of America.

The Federal Reserve had bet the farm QE2 last August and it has lost. The worst move here would be to double-down on QE3, because if it failed to rouse global markets in a sustained fashion, then the Fed's remaining credibility and "magic" would vanish in a puff of smoke.

Would you pull out your super bazooka American Express card now to patch over the last 3 years juggling act using the Mastercard to pay off the Visa debt balance?

The perception has now changed. Interest rates around the world are going to edge up over the next 6 months as the reference price of "risk-free" rates long revered in US Treasury bills are redefined. Should central banks decide not to move interest rates up in order to manage their fragile economies, then expect a degree of foreign exchange rate volatilty.

The impact for the next 6 months will be:

• The wealth effect will start to diminish as asset values become more "costly" to own and service. Will corporates and consumers continue to "pay more" and chase assets?
• Stock markets will have to rapidly adjust for and reflect the extra interest expenses within companies as debt (re)financing becomes more expensive. These are headwinds for those large leveraged companies and small businesses reliant on their bankers.
• Bonds prices trend downwards as investors rethink pricing in the context of a rising interest rate environment

What are the range of options and next steps available to ordinary consumers:

• Pare down stock market portfolios to eliminate as much market risk as possible, so long as financial markets remain vulnerable, and politicians lack real impetus to resolve sovereign debt concerns. Stay with boring stable companies eg utilities that generate dependable cashflows.
• Retain a strong cash component in portfolios to take advantage of potential fire-sale opportunities. Financial markets can over-react emotioally to the downside eg Oct. 2008 & Mar. 2009 as fundamentals get tossed out of the window in panicked dashes to the exits.
• Property investors (the above-water, positive-equity universe) should consider locking in their capital gains and take a breather.
• Assess the alternative of owning precious metals...gold and silver. Historically these have provided a store of value and risk/uncertainty hedge in volatile financial climates.

The US dollar's reserve status held since 1945 is waning. Over the last four weeks, the world has watched aghast as the internet era threw open the incessant bickering within the highest echelons of American government. The mantle of trust and faith in the creditworthiness of the USA, gingerly built up throughout the 20th century, is eroding. Asia is well positioned, but not guaranteed, to assume the economic vitality that has served America so well in the past.

QE3 will not be a panacea...more like Ben Bernanke riding to the rescue on a lame horse. Stay nimble and let the game come to you.