S&P said that the new rating reflected the Supreme Court's decision on Monday to not revisit a lower-court order for Argentina to pay so-called "holdout" bond holders. The hedge fund holdouts were part of a small group who refused to accept less money for their bonds and have for years sought full payment on the $1.33 billion they are owed. The American courts have ruled that the holdouts must be paid at the same time as the owners of new discounted bonds.
"The negative outlook reflects the likelihood of a further downgrade based on possible payment interruptions or the announcement of what we could consider a distressed debt exchange," S&P said. "Either a payment interruption or a distressed debt exchange would lead us to lower our rating on Argentina to [selective default]."
The downgrade comes as Argentine asset markets were dragged through more drama on Monday.
Stocks on the country's blue-chip Merval Buenos Aires index finished the session lower by over 10 percent on Monday, losing around 812 points. The Argentine peso remained relatively stable but bond yields spiked. The yield on Argentina's U.S. dollar-denominated 2017 global bond had risen to 15.833 percent by Tuesday morning, according to Reuters data, up from 11.545 percent before the ruling. Its U.S. dollar-denominated 2033 discount bonds were yielding 11.9389 percent, rising sharply from 10.6320 percent.
Brian Lawson, a global economic and financial consultant at research group IHS told CNBC via email that it's likely that the fastest market corrections are already behind us, but warned that the country's fundamentals had changed.
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"(There's) clearly increased risk of Argentine technical default: this could encourage further selling over time as well. So, while there may be technical bounces, with buyers attracted by the speed of price changes and apparent bargain prices, there are reasons to fear further falls over time," he said.
"The Supreme Court ruling was the worst possible outcome from an Argentine perspective," Lawson said. IHS had previously had a negative outlook on the Argentine peso but Monday's result has given further downward pressure on that estimate. IHS had predicted that the peso could be worth $12.2 by end year, with it currently trading at around $8, and $15.6 by the end of 2015.
"Sharper and earlier devaluation now represents a clear possibility. Far higher volatility in the peso also appears a severe risk," he said.
"Ironically, this may actually be good news, in that it could force Argentina to devalue faster, and with less prior use of its reserves to improve its international competitiveness, rather than doing so after a long and unsuccessful struggle to fight the markets. A devaluation appeared very likely given the country's weak economic fundamentals."