Credit Default Swaps Are Regaining Popularity Amid U.S. Debt Concerns, Though Panic
ECONOMY
May Be Overstated
Investors are increasingly purchasing credit default swaps (CDS) as a form of insurance against the possibility that the U.S. government might fail to meet its debt obligations. The cost of insuring U.S. government debt through CDS has been steadily rising, reaching levels near the highest in two years, according to data from LSEG.
CDS as a Hedge Against Political Risk, Not Insolvency
Rong Ren Goh, portfolio manager at Eastspring Investments, explains that the recent surge in demand for CDS contracts is driven by a desire to hedge against political risks, particularly related to fiscal policy uncertainty and political dysfunction, rather than a belief that the U.S. government is close to insolvency.
This uptick in CDS pricing aligns with growing investor anxiety over the unresolved debt ceiling issue. Freddy Wong, head of Asia Pacific fixed income at Invesco, notes that CDS have become popular again because the U.S. Treasury reached its statutory debt limit of $36.1 trillion in January 2025.
The Congressional Budget Office confirmed in March that the Treasury had no borrowing capacity left aside from replacing maturing debt. Treasury Secretary Scott Bessent recently indicated that a precise forecast of the so-called “X-date”—when borrowing capacity will be exhausted—is pending receipt of federal tax revenues around the April 15 filing deadline.
Historical Context and Current Legislative Outlook
Historical data from Morningstar shows that spikes in CDS spreads on U.S. government debt typically occur during periods of heightened debt ceiling concerns, such as in 2011, 2013, and 2023.
Despite the current uncertainty, Wong emphasizes that several months remain before the X-date is reached. The U.S. House of Representatives has passed a tax cut package that could raise the debt ceiling by $4 trillion, subject to Senate approval.
In a May 9 letter, Bessent urged Congress to raise the debt ceiling before the annual August recess to avoid an economic crisis, though he acknowledged “significant uncertainty” regarding the exact timing.
During the 2023 debt ceiling crisis, Congress averted default by suspending the ceiling just days before a technical default would have occurred. Historically, Congress has acted at the last moment to raise or suspend the ceiling when necessary.
CDS Price Surge Seen as Temporary and Not Indicative of Impending Crisis
Industry experts view the current surge in CDS prices as a short-term reaction while investors await a budget deal. Unlike the 2008 financial crisis—when CDS linked to mortgage-backed securities reflected real default risks—today’s CDS demand on sovereign debt is considered speculative and unlikely to predict an actual default.
Spencer Hakimian, founder of Tolou Capital Management, contrasts the current sovereign CDS situation with the corporate CDS environment of 2008, highlighting that investors today are more focused on political risk than genuine insolvency threats.
Ed Yardeni, president of Yardeni Research, confidently states that the U.S. government will prioritize paying its debt obligations, dismissing fears of default as unjustified.
Credit Rating and Future Risks
Moody’s recently downgraded the U.S. sovereign credit rating from Aaa to Aa1, citing worsening fiscal health. Should the Senate approve the proposed debt ceiling increase, Treasury issuance will rise, potentially renewing focus on the U.S. fiscal deficit.
As of the latest data, spreads on 1-year U.S. CDS contracts have risen to 52 basis points from 16 at the start of 2025, while 5-year CDS spreads stand near 50 basis points, up from 30. CDS function as recurring insurance premiums paid by buyers to sellers; if a default occurs, sellers must compensate buyers.