I am working on creating a workable tinyconfig kerne

Ok. Please try the same scenario with a "full kernel config" as well - obviously kernel needs to support console for example for some dracut features to work.

During my creation, I had already been testing using the Image from ArchLinuxARM-aarch64-latest.tar.gz, and the effect is the same with that.
Technically it isn't "full", as-in not everything is selected (like CONFIG_SQUASHFS_ZSTD), but I figure if it isn't going to work for a dist, it likely won't work with everything kernel config selected, and something like a compression scheme config setting isn't going to have any effect on this issue.

obviously kernel needs to support console for example for some dracut features to work.

I mean, I've got it working when I leave out those other debug arguments, and it only fails to take any rd.* action when using either of those other debug arguments.
I wouldn't see the correlation with any config setting changing that effect.
If I didn't even have console set or have the ARM AMBA serial config setting enabled, I'd see nothing.

I know I included a lot in the -append above, but let me make it simple for your own testing:
Success: -append "console=ttyAMA0 rd.debug=1
Fail: -append "console=ttyAMA0 rd.debug=1 debug

I've done my part now. Feel free to see if it works with whatever kernel you currently have. I am equally doubtful it is an arch-based issue. You don't even have to make a qcow. Just kernel and image and append arguments.