Investor Demand for U.S. Debt Protection Soars as CDS Spreads Reach Record Highs Amid Fiscal Policy Uncertainty
Investor demand for credit protection on U.S. government debt has increased, with CDS spreads reaching post-2023 highs due to fiscal policy concerns and political risks. As of May 2, 2025, the notional value of active CDS contracts rose to $3.9 billion from $2.9 billion at the year's start, per Barclays. This reflects heightened hedging activity amid fears of a U.S. default. Swiss pension funds are reducing U.S. asset exposure due to high hedging costs and trust issues. The CDS market's growth indicates shifting investor sentiment, with the implied default probability now above 1%.
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05/09 21:00
Investor Demand for U.S. Debt Protection Soars as CDS Spreads Reach Record Highs Amid Fiscal Policy Uncertainty
Investor demand for credit protection on U.S. government debt has increased, with CDS spreads reaching post-2023 highs due to fiscal policy concerns and political risks. As of May 2, 2025, the notional value of active CDS contracts rose to $3.9 billion from $2.9 billion at the year's start, per Barclays. This reflects heightened hedging activity amid fears of a U.S. default. Swiss pension funds are reducing U.S. asset exposure due to high hedging costs and trust issues. The CDS market's growth indicates shifting investor sentiment, with the implied default probability now above 1%.
CDS Spreads Widen Across the Curve
Spreads on U.S. sovereign CDS have widened sharply in recent weeks, with one-year and five-year contracts trading at 60 and 56 basis points, respectively, as of Friday, May 9, according to S&P Global Market Intelligence. These levels are the highest since May 2023, when the U.S. faced a similar episode of political gridlock over the debt ceiling. While slightly below their recent peaks, the spreads remain significantly elevated compared to March levels, reflecting persistent investor anxiety.
The increase in CDS pricing has not been limited to short-term maturities. Spreads have risen across the curve, indicating that concerns are not confined to near-term political risks but extend to broader fiscal sustainability and policy direction. According to Barclays, the U.S. CDS market has become the 12th most actively traded single-name CDS globally over the past three months, with weekly trading volumes averaging over $625 million.
Policy Uncertainty and Political Risk Drive Demand
The surge in hedging activity comes amid renewed political uncertainty in Washington. The U.S. government reached its statutory borrowing limit in January 2025 and has since been relying on "extraordinary measures" to avoid breaching the cap. Treasury Secretary Scott Bessent testified this week that the department is "on the warning track" in terms of remaining borrowing capacity, though he reiterated that the government would not default on its obligations.
Barclays analysts estimate that the so-called "X-date"—the point at which the Treasury will no longer be able to meet all its obligations—could fall in late August or early September. However, they caution that an economic slowdown could accelerate the timeline by weakening tax receipts and depleting the Treasury’s cash reserves more quickly.
Investor concerns were further amplified after former President Donald Trump announced sweeping tariffs on April 2, triggering a sharp selloff in the Treasury market. Although a 90-day pause on most tariffs was later announced, the episode contributed to a rise in the risk premium embedded in Treasury yields. Benchmark 10-year yields, which had spiked to 4.56% in the wake of the tariff announcement, have since eased to 4.36%, but the underlying policy risk remains elevated.
Swiss Pension Funds Reassess U.S. Exposure
The rise in U.S. CDS spreads and broader concerns over fiscal policy have prompted institutional investors abroad to reassess their exposure to U.S. government debt. Swiss pension funds, in particular, have begun reducing their holdings of U.S. dollar-denominated assets, citing high hedging costs and a perceived erosion of trust in the U.S. as a sovereign issuer.
Andreas Rothacher, head of investment research at Swiss consultancy Complementa, noted during a recent conference call that there is a “certain loss of trust” in U.S. fiscal management. Swiss pension schemes have already begun trimming their allocations to foreign currency government bonds, including U.S. Treasuries, in favor of corporate credit and other asset classes.
Publica, Switzerland’s largest pension fund, has underweighted U.S. equities and is currently reviewing its overall investment strategy. The fund is also considering a broader reduction in its allocation to government bonds, citing rising debt levels not only in the U.S. but also in other developed markets such as China.
CDS Market Growth Reflects Shifting Investor Sentiment
The growth in the U.S. CDS market reflects a broader shift in investor sentiment. Once considered a niche product, CDS on U.S. sovereign debt are now attracting significant attention. According to Barclays, the outstanding volume of CDS contracts has increased by nearly $1 billion since the beginning of the year. This rise in demand suggests that more investors are seeking insurance against the possibility of a U.S. default, however unlikely.
Greg Peters, co-chief investment officer at PGIM Fixed Income, noted that “no one wants to be short that option” in the current environment. He added that the combination of debt ceiling uncertainty and broader policy unpredictability has made CDS protection a more attractive hedge.
The implied probability of a U.S. default, based on current CDS pricing and Treasury bond valuations, stands just above 1%, according to Barclays. While still low, this figure is notable given the historical perception of U.S. debt as virtually risk-free. The payout ratio on CDS contracts has also increased, with the cheapest-to-deliver bond now priced at around $48, compared to $56 in May 2023, implying a higher potential return for protection buyers.
Broader Market Implications
The rise in CDS spreads and hedging activity has coincided with increased volatility in the Treasury market. The New York Federal Reserve has highlighted the potential for instability stemming from large basis trades—leveraged positions that exploit pricing differences between Treasury futures and interest rate swaps. As of March 2025, the notional value of short Treasury futures positions held by leveraged funds stood at approximately $1 trillion, well above pre-pandemic levels.
A sudden unwind of these trades could overwhelm dealer balance sheets and exacerbate market stress, particularly if political negotiations over the debt ceiling deteriorate. While Treasury markets remain among the most liquid globally, the recent turbulence underscores the sensitivity of investors to policy signals and fiscal developments.
