The downgrade of Greece's credit rating gave pause to the "risk trade" and could send even more buyers into the relative safety of Treasurys through year end.
The dollar strengthened, bonds moved higher and the stock market sold off Tuesday as investors fretted about the strength of the global recovery and concerns that Greece's fiscal problems are the precursor for other global trouble spots. The Dow was down 105 points, or 1 percent at 10,285, while the S&P 500 fell 1 percent to 1091.
"It's sort of a panoply of issues. The bigger issue is risk aversion and problems with sovereign debt. You're starting to see the data for the U.S. and Eurozone disappoint. German industrial production today was much weaker than expected," said Boris Schlossberg of GFT Forex. Even the U.S. debt rating was a topic of discussion Tuesday, after Moody's said the U.S. and U.K. must prove they can trim their growing deficits to avoid threatening their triple A credit ratings.
Several corporate stories Tuesday also soured the tone. McDonald's reported same store sales fell 0.6 percent in November, below forecast, and 3M also issued a forecast that missed expectations.
On Wednesday, wholesale trade is reported at 10 a.m. and the Treasury auctions $21 billion in 10-year notes.
John Spinello, Treasury strategist at Jefferies, said the auction of $40 billion in 3-year notes Tuesday went relatively smoothly with strong demand from domestic and foreign buyers. "There's a flight to quality going on and there's a flight out of risk assets right now," he said. "The stock market is doing a consolidation right now and I guess it could last until the end of the year. The dollar and yen are both seeing short covering. Those are both currencies used for carry trade."
Spinello said it was the Greek debt news that initially spurred buyers Tuesday. Just a day after another agency put Greece on credit watch, Fitch said it was cutting Greek debt to BBB+ from A due to fiscal deterioration, giving it the lowest debt rating in the Euro zone. Yields fell as buyers moved into the short end of the bond market, even driving the 1-month bill to a zero yield in the Tuesday morning auction. That was the fourth time in history it was ever auctioned at zero.
"Fixed income will be the beneficiary for the time being. I think the stock market is a little concerned about what's going on right now, with the Dubai thing, the European debt. I don't think it's the end of the rally in stocks, but it's just a well needed consolidation, and the banks are usually the leader," Spinello said. Citigroup, Bank of America, J.P. Morgan and Wells Fargo were all lower on the day.
"Everybody's talking about the Greek downgrade," said one stock trader, who also said the short end of the bond market was benefiting. "..There's a little fear in the marketplace, but the credit markets outperformed equities all day. It's a kind of trading call right now." He and others also pointed out that many major investors have been sitting out the end of the year, happy to hang onto sizeable gains.
Schlossberg said he thinks the dollar's move higher will be short-lived. "By no means do I think this is a major turning point for the dollar, primarily because ultimately it's still really about interest rates. It's a much needed but temporary correction," said Schlossberg.
"It really feels like we made a near term top in the euro/dollar right now, and I think we could trade all the way down to 1.45."
The House Financial Services Committee meets at 10 a.m. Wednesday on the Securities Investor Protection Act. The Senate Judiciary committee holds a hearing on mortgage fraud and the financial meltdown at 2 p.m., and the Senate banking committee holds a 3 p.m. hearing on job creation.
— Questions? Comments? marketinsider@cnbc.