One way to judge how worried the market is about Washington's poisonous politics is to look at the cost of insuring U.S. Treasuries. If investors are becoming more concerned about a potential default, then that cost will rise. You can see this cost through credit default swap (CDS), which are derivatives used to protect against bond default. As you might expect, as the August 2nd deadline for extended the debt ceiling looms, spreads on CDS for Treasuries have been widening.

Here's the chart, from data provided by Markit through Friday's last indicative quote:

UST CDS 2011-07.png

This chart warrants some explanation. First, the CDS referenced by these two curves represent to periods of time for which U.S. Treasuries are insured. The 1-year line (red) represents CDS insuring Treasuries for a year, while the 5-year line (blue) represents CDS insuring Treasuries for five years.

The cost of that insurance at a given point in time is reflected by the spreads shown. Think of the spread as basis points. For example, as of today, the spread for 1-year U.S. Treasury CDS was 75 basis points. In other words, to insure €10 million in Treasuries, would cost €75,000.

The spread is also an annual cost. So for the 5-year line, the 60-point spread represents a cost of €60,000 per year to insure €10 million in Treasuries.

With the chart explained, we should note two observations. First, the obvious one: spreads rose this week. This indicates that investors are getting nervous about U.S. debt. The 1-year protection rose considerably, from 53 basis points last Friday to end the week at 75 basis points. The 5-year protection rose by a little bit less, to 60 from 53 a week ago.

And this begins to hint at the other oddity of this chart: the curve is inverted. It actually costs more to insure Treasuries over a short period than it does over a longer period. This might seem nonsensical: isn't it worth more to have protection over a longer period of time? The short answer is yes, but it's complicated. Because the five-year CDS requires an annual premium, its total cost is actually greater. And right now, if the U.S. does somehow manage to default, chances are fairly high that it will get its act together at some point in the next year, which means that the cost to insure it for years 2 through 5 should be relatively lower.

So just how expensive is the cost of one-year protection on Treasuries on a relative scale? Well it's obviously a lot more expensive than it was as recently as last spring. It cost just 13 basis points for the 1-year protection as of May 18th. It peaked at 82 this week.

Still, at it's current price of 75, CDS on U.S. Treasuries is relatively cheap compared to nations with severe fiscal problems. The prototypical example here is Greece. Today, protection on Greek debt cost 1,675 points. In other words, it costs nearly $1.7 million to protect against $10 million in Greek debt.

In short, Wall Street is starting to sweat a little over the possibility of U.S. default, but not a lot. If no deal is struck this weekend, however, we may very well see spreads widen even farther on Monday. After all, Tuesday is the date the Treasury claims its extraordinary measures will run out of juice.

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