US credit-default swaps show rising risk. Should investors worry?

In markets, subtle signals can herald approaching storms. Among these leading indicators, the term structure of credit spreads warrants special attention. Capturing perceptions of both short- and long-term credit risk, it can serve as an early-warning system. 

For instance, when a company approaches default, the curve of its credit spread tends to rise and invert, driving short-term spreads higher than longer term ones, indicating immediate danger. Credit portfolio managers worldwide are wary of this classic risk signal. 

Could the term structure of credit spreads also alert us to systemic risk affecting the US economy? Looking at US credit-default swaps (CDSs) and their behaviour during past debt-ceiling budget crises tells us that markets often whisper about the American deficit. Add the fact that credit curves often speak before newspaper headlines emerge, and the case for using CDS markets to assess the credit risk of the US economy grows.

This week, Simply put examines recent CDS moves and considers how they might inform our multi-asset portfolio allocations.

Read more: The here and now: when markets react more to short-term conditions

How spreads draw a credit event

In normal times, short-term credit spreads on bonds are lower than those of long-term spreads. Because short-term risks are more visible, long-term risk is mechanically higher, resulting in the term structure of credit spreads usually moving higher over time.

But when a company approaches default on a coupon or a principal payment, the term structure of its credit spread gradually shifts. Reflecting this immediate risk, short-term spreads rise faster than long-term spreads. An issuer judged to be on the brink of default sees its spread term structure invert and slope downward.

So, what are CDS markets telling us about US credit risk? Figure 1 shows the evolution of US CDS spreads, which act as insurance against US credit defaults. Usually, the term structure of these spreads oscillates between zero and 40 basis points, regardless of maturity. Between January and May 2023, the US government faced the risk of renegotiating its famous debt ceiling. The risk of failure in these negotiations could have triggered a credit event, prompting the CDS term structure to react in the following way:

• Spreads broadly rose to levels consistent with the risk of default by a sovereign-debt issuer
• The term structure inverted, with 1-year CDS approaching 180 bps while 10-year CDS reached 60 bps.
   

In brief, this debt-ceiling issue led markets to react as they would to a scenario of acute corporate-credit risk. When a Congressional agreement dissipated this risk, the term structure and spread levels of the CDS instruments normalised rapidly. 

FIG 1. Term structure and spread levels of US CDSs (EUR) by maturity¹

Market effect

This period of curve inversion, from January to May 2023, and normalisation by 10 June 2023 is typical of market reactions to sovereign risk. Was it reflected in major indices beyond CDS markets? Figure 2 shows the impact of the debt-ceiling drama on different markets, helping us better understand the reach of sovereign risk in financial markets.

The short answer is no. The graph leaves little room for doubt, showing that:

• The dollar lost some value during the spread inversion phase before recovering during its normalisation
• Other asset classes showed no signs of stress: Treasuries remained positive (despite increased risk on the US issuer) while global, US and European equities gained.
   

Yet it’s important not to rush to conclusions. This situation may not have signalled a global market collapse, but let’s also consider former UK Prime Minister Liz Truss's mini-budget of 2022 as another case study. In this instance, both UK bonds and stocks suffered alongside sterling. 

FIG 2. Market performance during the US CDS term structure inversion and normalisation in H1 2023² 

What about today's risk?

Markets do not perceive the Trump Administration in a similar light as the team led by Joe Biden In 2023. This is evident in current CDS spreads on US sovereign debt.

Figure 3 shows the recent evolution of the CDS term structure, illustrating that even before the latest debt-ceiling renegotiations, Donald Trump’s “big beautiful bill” to extend tax cuts was weighing on the US budget deficit after neither DOGE’s actions nor increased tariffs provided funding solutions. Thus, not only has the CDS market broadly elevated, indicating rising risk, the term structure has also begun losing its upward slope, declining from 20 to 15 bps over the year. 

While it is too early to sound an alarm, the market is showing some nervousness by hedging demand. If this risk continues to grow, we should closely monitor movements to assess whether markets judge the situation to be reminiscent of 2023 or as something more significant.

FIG 3. Changes in US CDS term structure, December 2024 to June 2025³ 

The investment implications for multi-asset investors

In recent weeks, the positioning in our All Roads range of multi-asset strategies has generally shifted from defensive to merely cautious. The risk associated with Donald Trump’s signature bill remains real and present, but the market is not exhibiting signs of panic. As in 2023, we find no trace of this risk in the trends we follow or among our risk appetite signals. Therefore, in this context, our market exposure has steadily increased.

Simply put, US default risk has increased. As yet, this has not caused market stress but the situation requires ongoing monitoring.
 

Macro/nowcasting corner

The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises, and global monetary policy surprises is designed to track the progression of macroeconomic factors driving the markets.

Our nowcasting indicators currently show:

• Our growth nowcaster has increased compared to last week across most regions
• Since the beginning of April, our inflation indicator has continued its downward trend globally, but exhibits a high and rising trend
• Globally, our monetary policy nowcaster has risen, particularly in the Eurozone and China, while it has declined in the United States. The eurozone indicator is approaching the 50% threshold. 
   

World growth nowcaster: long-term (left) and recent evolution (right)

Reading note: LOIM’s nowcasting indicators gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).