Investor sentiment is growing uneasy as concerns mount over the U.S. government’s ability to meet its debt obligations. In response, many are turning to credit default swaps (CDS) as a form of financial protection against potential defaults.
Data from LSEG indicates that the cost of insuring against U.S. government debt has climbed steadily, nearing a two-year peak. As of Wednesday, the spread on one-year credit default swaps rose to 52 basis points, a significant increase from just 16 basis points at the beginning of this year.
Credit default swaps function like insurance for investors; they provide protection against the risk that a borrower—in this case, the U.S. government—will fail to repay its debts. An increasing cost for this insurance signals growing concerns among investors regarding the safety of U.S. debt.
In addition, the spreads for five-year CDS contracts have also surged, reaching nearly 50 basis points compared to around 30 basis points at the start of the year. Under a CDS agreement, the buyer pays a recurring fee, or spread, to the seller. If the U.S. government defaults, the seller is liable to compensate the buyer.
According to Rong Ren Goh, a portfolio manager at Eastspring Investments, fluctuations in CDS prices indicate perceived borrower risk and serve as a measure of financial distress, not solely as indicators of potential outright defaults. Goh noted the uptick in CDS demand reflects apprehension stemming from political instability, rather than a direct belief that the government is on the brink of failure.
Industry observers have pointed out that investor concerns are closely tied to the ongoing uncertainty surrounding the debt ceiling. Freddy Wong, head of Asia Pacific fixed income at Invesco, remarked on the renewed popularity of CDS contracts amidst the unresolved debt ceiling situation, noting that the U.S. Treasury hit its statutory borrowing limit back in January 2025.
In March, the Congressional Budget Office reported that the Treasury had already hit its debt ceiling of $36.1 trillion with no available room for borrowing except to replace maturing debts. Treasury Secretary Scott Bessent stated earlier this month that the department is currently evaluating federal tax receipts from the April 15 deadline to provide more clarity on the timing of the “X-date,” when the U.S. government will fully exhaust its borrowing capacity.
Historical data from Morningstar indicates that spikes in CDS spreads have often coincided with periods of heightened concern over the U.S. government’s debt limit, particularly in the crises of 2011, 2013, and 2023. Wong also emphasized that there is still time before the X-date, which is a critical threshold for government borrowing.
The U.S. House of Representatives has recently passed a significant tax cut package that could potentially raise the debt ceiling by $4 trillion, pending approval from the Senate. In a letter sent on May 9, Bessent urged congressional leaders to extend the debt ceiling by July to avoid economic disruption, warning that there remains “significant uncertainty” regarding the timeline.
Wong added that the Senate still has sufficient time to pass its version of the bill before the end of July, thus preventing a technical default on U.S. Treasury obligations. During past debt ceiling standoffs, Congress has often intervened at the last minute to prevent a default from occurring.
Fiscal reckoning
The recent rise in CDS pricing is likely to be a temporary reaction as market participants await a new budget resolution to raise the debt limit. Analysts believe it is not indicative of an impending financial crisis.
Unlike the 2008 financial crisis, during which CDS tied to mortgage-backed securities were actively traded amid high-risk situations, the current surge in sovereign CDS demand paints a different picture. According to Spencer Hakimian, founder of Tolou Capital Management, the motivations behind sovereign debt CDS demand differ significantly from those in corporate debt scenarios during the 2008 crisis.
Ed Yardeni, president of Yardeni Research, emphasized that market players may be using CDS contracts to speculate on a government debt crisis, a scenario he finds extremely unlikely. He reiterated his belief that the U.S. will always prioritize fulfilling its debt obligations, stating, “The U.S. government won’t default on its debt. The fear that it might do so is not justified.”
In a recent move, Moody’s downgraded the U.S. sovereign credit rating from Aaa to Aa1, citing deteriorating fiscal conditions. Wong warned that if the Senate manages to pass the bill before the deadline, the resulting surge in Treasury supply could re-focus attention on the U.S. fiscal deficit situation.
