A few readers have questioned the use of credit default swap (CDS) prices as a determining factor in setting interest rates. Please note that CDS is beyond the control of the Federal Reserve. Prices about the default risk insurance on the United States are set in global markets and really determined by the buyers and sellers from around the world, with very little participation by American investors.
Here’s a table of the starting and ending CDS prices on the United States according to Bloomberg data. This is for the calendar year 2023.
12/30/22 12/29/23
1Y CDS 15.230 36.275
5Y CDS 24.970 46.410
10Y CDS 32.865 55.050
Note that these prices are in euros and in basis points. Each basis point is 1/100th of 1%.
Some have asked how much of this price change is due to the expanding federal deficit and how much is due to the political turmoil of debt ceiling default threats and lack of budget resolutions. That is a fair question.
Here’s my take.
At the beginning of 2023, the federal deficit trajectory was known and had been discussed for years. The projections of the future deficits were known and the updated regularly by various agencies including the Congressional Budget Office (CBO). CDS prices have been rising consistently for years but in very small increments except when the debt ceiling debate threat was in play. 2011 and 2013 were when it threatened. So, we have some history to guide us.
In my opinion, the difference between the starting 2023 CDS prices and the ending 2023 CDS prices is almost entirely due to political dysfunction and the House culture war antics. Thus, we can estimate that about 20 basis points have been added as a permanent shift to the financing costs of America. Note that there is about $27 trillion tradable US federal debt and about a total of $70 trillion US dollar-denominated debt. We don’t know how much of the CDS cost translates to the nonfederal dollar-denominated debt. Certainly, some does.
Using just the federal debt, we can now argue (infer) that the antics in the House are costing the United States about $55 billion a year in financing costs (interest rates higher than they would otherwise be).
Below are three charts. They show the 1-year, 5-year, and 10-year CDS trading during the year 2023. When you look at them remember that the early part of the year (2023) was the debt ceiling default risk period, which peaked in May when McCarthy and Biden shook hands on debt ceiling default avoidance. Then McCarthy was ousted by his Republican peers and the new-Speaker battles began, with Johnson prevailing as the new Speaker. Johnson has been in a sequential pattern of short-term continuing resolutions on the budget but no longer-term settlement and no agreement with the Senate. CDS rates are below their May peaks but are still elevated as we move into 2024. They remain elevated today.
Here are the three charts. Hat tip to my colleague Shaun Burgess.
-David
Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.
Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.
