"Not The End Of The World"

Some on Wall Street also downplayed the immediate impact.

"If a corporate entity had the same kind of unsustainable leverage problems, it would have been downgraded long ago," said Robert Bishop, chief investment officer of fixed income at SCM Advisors in San Francisco.

"But from the standpoint of the sovereign, being on outlook negative is not the end of world," he added. "Japan, for example, is a double-A credit."

Related readings:  Obama to reduce deficit by $4 trillion  US federal deficit to reach $1.65 trillion in 2011

S&P downgraded Japan's rating earlier this year for the first time since 2002, saying Tokyo had no plan to deal with its mounting debt burden.

But unlike the United States, almost all Japanese debt is held by domestic investors. That means the country need not depend on foreigners for financing.

Axel Merk, president of Merk Hard Currency Fund in Palo Alto, California, said Monday's warning was "a wake-up call that we need to do something in the US" S&P is "absolutely correct that this is something serious that needs to be addressed."

Moody's, S&P's main rival in the ratings business, also maintains a Aaa credit rating - its highest - on the United States.

For PIMCO, the world's largest bond fund, the picture had become bleak enough to prompt it to announce in February it had sold all US Treasuries in its $236 billion Total Return Fund .

Bill Gross, PIMCO's chief investment officer, said he expected interest rates to climb, the dollar to fall and the United States to eventually lose its AAA credit rating.

The ratings agency said neither the White House nor Republican plan does enough to fix the shortfall, and the tension between the parties has cast doubt on whether they will be able to work together on a long-term solution.

"Looking at the gulf between the parties, it has never been wider than now," David Beers, S&P's global head of sovereign ratings, said on Monday. "It takes a lot of political will to bridge this gulf."

A US congressional report last week blamed ratings companies such as S&P and Moody's Corp for triggering the financial crisis when they cut the inflated ratings they had applied to complex mortgage-backed securities.

George Feldenkreis, CEO of Perry Ellis International, said that casts doubt on S&P's outlook.

The ratings agency "does not have the intellect or systems to judge the ability of the US economy or political system to resolve its issues of taxation and needed budget cuts," he said.

Moody's put some issues of US Treasury debt on watch for a downgrade in 1996 when the White House and Congress failed to extend the government's debt ceiling.

The two sides are heading for a similar showdown over the $14.3 trillion legal borrowing limit, which will have to be extended within weeks.

Souring On The Dollar

The US debt burden has grown exponentially after a housing bubble burst in 2007 and set off a world financial crisis that toppled several Wall Street banks, drove up the jobless rate and thrust the global economy into recession.

Governments around the world were forced to increase public spending to prevent their economies from lurching into an even worse depression.

The tactics helped spark a recovery but left the United States and other advanced economies, which were hit hardest by the crisis, with staggeringly large debt burdens.

Though it rose on Monday, the dollar is down about 5 percent against major currencies in 2011. S&P's move, coupled with record low US interest rates, will do little to make it more attractive, said Kathy Lien, director of research at GFT.

"Even though I don't think an actual downgrade would occur, in this very sensitive or vulnerable time for the US dollar, it's enough to spook investors from holding or buying dollars," she said.