Odds of US debt default have already tripled this year

The probability of an unprecedented US default has more than tripled since the start of the year as Congress struggles to reach a new debt ceiling deal, according to a leading international finance firm.

Analysts at MSCI pointed to “a noteworthy pick-up in trading activity” of US-linked credit default swaps, or CDS, this year as Treasury Secretary Janet Yellen and others warn the federal government is running out of money to cover its debt obligations.

The implied probability of a US default hit 11.3% as of Feb. 24, up from just 3.3% at the start of the year, according to MSCI’s analysis of CDS trading activity.

The risk of a US default is higher now than it was at any point since the debt ceiling battle in 2013, the analysts said.

“The consequences of a potential default by the US government extend beyond the immediate impact on holders of Treasurys,” MSCI analysts said in a blog post. “Major market dislocation and a sharp slowdown in economic activity could both be realistic possibilities.”

Credit default swaps, or CDS effectively function as an insurance policy for investors who hold bonds. If the bond holder defaults, the swaps act as a hedge against the resulting losses.

“In the absence of legislative agreement, CDS trading volume on the US government may continue to strengthen as summer approaches, and the possibility of missing payments on US Treasurys looms larger,” the MSCI analysts added.

Republicans and Democrats have remained deadlocked on a potential deal to raise the debt ceiling and avert a default. The US government reached its $38.381 trillion borrowing limit in January.

President Biden and his Democratic allies have argued the debt ceiling should be increased without conditions. Republicans, including House Speaker Kevin McCarthy, argue the borrowing limit shouldn’t be raised without cuts to federal spending.

The Treasury Department has since implemented “extraordinary measures” that will allow the federal government to maintain operations through at least early June.

In a January letter to McCarthy, Yellen warned a US debt default would “cause irreparable harm to the US economy, the livelihoods of all Americans, and global financial stability.”

Earlier this year, JPMorgan Chase CEO Jamie Dimon said US creditworthiness is “sacrosanct” and should not be tested in a political battle.

“That is part of the financial structure of the world. This is not something we should be playing games with at all,” Dimon told CNBC.