US CDS Spreads Signal a Gray Swan Fiscal Crisis: Implications for Bonds and Equities

The United States, long the bedrock of global financial stability, now finds itself in uncharted fiscal territory. As of June 2025, its sovereign credit default swap (CDS) spreads—once a barometer of perceived default risk—have surged to levels last seen during the debt ceiling crises of 2011 and 2023. Yet this time, the stakes are higher. The

now aligns with those of BBB-rated nations like Italy and Greece, a stark reminder that political dysfunction has become a systemic risk. This is not a black swan—unpredictable and unforeseen—but a gray swan: a known hazard that markets have ignored at their peril. The implications for bonds and equities are profound.

The Fiscal Gray Swan Takes Flight

The US Treasury's debt ceiling impasse, unresolved since January 2025, has pushed CDS spreads to historic highs. By mid-June, the 1-year US sovereign CDS had climbed to 52 basis points (bps), nearly tripling from its January 2025 low of 16 bps (). This mirrors the spreads of Italy and Greece, both rated BBB+ by S&P and Baa3 by Moody's, signaling that investors now view US fiscal credibility through the lens of nations grappling with chronic debt.

The downgrade of the US to Aa1 by Moody's in May 2025 underscores the erosion of confidence. While the US remains solvent, the political brinkmanship over a $4 trillion debt ceiling increase has exposed vulnerabilities. Treasury Secretary Scott Bessent's warning of “significant uncertainty” ahead of the “X-date” (when borrowing capacity is exhausted) has fueled hedging activity. CDS buyers are not betting on default—Ed Yardeni of Yardeni Research insists a default is “extremely unlikely”—but they are pricing in the risk of prolonged fiscal instability.

Global Risk Premiums Under Stress

The US fiscal crisis is no longer a domestic issue. As the world's reserve currency issuer, its credit risk ripples across markets. Investors are recalibrating global risk premiums, with two critical consequences:

1. Safe Haven Assets Reprice Higher
   The demand for safety is pushing Treasury yields upward. The 10-year Treasury yield has climbed to 4.48% by June 2025 (), reflecting both inflation fears and fiscal uncertainty. Paradoxically, even as CDS spreads rise, Treasuries remain the go-to haven—though their allure may wane if the debt ceiling isn't resolved by July.

Meanwhile, high-yield and corporate bonds face headwinds. Investment-grade corporates have outperformed Treasuries this year, but their spreads could widen if fiscal anxiety spills into corporate credit markets. The outperformance of collateralized loan obligations (CLOs)—offering yields of 5.6% (AA-rated) to 11.2% (BB-rated)—hints at a broader flight to structured products perceived as “safer” than unsecured corporate debt.

1. Equities Face a Reality Check
   Overvalued growth sectors are particularly vulnerable. The S&P 500's price-to-earnings (P/E) ratio of 22x in June 2025 exceeds its 20-year average of 17x (). With risk premiums rising, investors are likely to abandon speculative equities for defensive assets.

Tech and consumer discretionary stocks—already battered by tariff-driven inflation—could suffer further. Conversely, utilities and healthcare sectors, with stable cash flows and low leverage, may outperform. A shift toward dividend-paying stocks and low-volatility indices is already visible.

Immediate Investment Implications

The clock is ticking. With the Senate needing to act before its August recess to avoid an “X-date” default, investors should prepare for volatility. Here's how to position portfolios:

• Hedging the Fiscal Gray Swan:
  Increase allocations to short-term Treasuries and inverse equity ETFs (e.g., S&P 500 Put Options) to guard against a selloff. CDS-linked derivatives could also be used, though with caution given liquidity risks.

• Avoid Overvalued Equities:
  Reduce exposure to high-beta stocks (e.g., Tesla, Amazon) and sectors reliant on borrowing (e.g., real estate). Rotate into defensive names like Microsoft, Johnson & Johnson, and dividend aristocrats.

• Leverage the Yield Environment:
  Explore short-duration corporate bonds with BBB+ ratings or higher, but avoid issuers with high leverage. CLOs, with their seniority in capital structures, remain attractive.

Conclusion: The Fiscal Gray Swan Demands Action

The US fiscal crisis is not an anomaly—it's a predictable consequence of decades of debt accumulation and political gridlock. Markets are finally pricing this reality. For investors, the message is clear: favor safety, avoid overvaluation, and prepare for a reset in risk premiums. The window to act is narrowing. The Senate's July deadline is not just a political milestone—it's a countdown to a reckoning with the fiscal gray swan.

As the CDS spread climbs, so does volatility. The time to act is now.