AI Debt Frenzy Revives Credit Default Swap Market

Key points

• CDS trading volumes for AI companies have surged, with the net notional value of AI-related CDS rising from under $7bn to nearly $30bn in one year, according to Barclays.
• Oracle is the largest and most active corner of the US CDS market, with four-week average weekly trading volume of $2.3bn and open interest of nearly $7bn.
• CoreWeave’s CDS prices are exceptionally high, reflecting significant credit risk, while other major AI firms like Nvidia and Broadcom show rising but manageable premiums.
• The AI cohort now accounts for nearly 14% of the entire American single-name CDS market, up from 4% a year ago, with trading volumes quadrupling to about 20% of the market.
• Investors are using CDS to hedge against the risk of AI infrastructure spending unraveling, despite most tech companies maintaining investment-grade ratings.

Background

Credit default swaps gained prominence during the 2008 global financial crisis as insurance-like derivatives protecting against debt default. They had faded in relevance for many tech companies in recent years but have recently returned as a key tool for managing AI-related credit risk. The current surge reflects broader market concerns about the sustainability of trillions of dollars in AI infrastructure spending, which is largely debt-financed.

How outlets are covering it

The Financial Times emphasizes the structural revival of the CDS market, highlighting how AI has transformed it from a niche instrument into a major component of the US single-name CDS market. It notes that while CDS prices for most AI firms are not indicating imminent default, the rise in open interest and trading volumes signals growing investor nervousness. The New York Times, in contrast, frames the situation as a 'crack' in the AI borrowing binge, focusing on the broader sell-off in tech stocks and investor concerns about the debt-fueled spending spree. While the FT highlights the mechanics and market share of CDS, the NYT underscores the potential systemic risks and market volatility associated with AI debt.

Why it matters

The resurgence of CDS in the AI sector signals a shift in investor sentiment, moving from optimism to caution regarding the sustainability of AI infrastructure spending. As CDS volumes and open interest surge, they serve as a real-time gauge of creditworthiness, potentially influencing borrowing costs and market stability. The dominance of Oracle and the extreme pricing of CoreWeave highlight the uneven risk distribution within the AI ecosystem, which could impact broader financial markets if defaults occur.

What to watch

Investors will likely continue to monitor CDS prices and trading volumes as indicators of AI sector health. If the AI boom unravels, CDS could become a critical tool for managing credit risk. Additionally, the growing 'basis' between CDS and bond prices may attract arbitrage opportunities, further influencing market dynamics. The next few months will be crucial in determining whether the current nervousness translates into actual defaults or remains a speculative hedge.