2008 Redux! An Overview of Wall Street’s Hottest Trade: AI CDS

Barclays released a comprehensive report on the credit default swaps (CDS) market for artificial intelligence-related companies, pointing out that with significant expansion in capital expenditures, the credit risk of AI-related companies has been markedly repriced, with both CDS trading volume and spreads showing a sharp upward trend.

On October 29, Barclays reported that the 10 core AI companies, including large-scale cloud service providers such as Google, Amazon, Meta, Microsoft, Oracle, and chip manufacturers such as AMD, Broadcom, Nvidia, currently account for only 8% of the CDX Investment Grade Index constituents, but already represent 16% of the index's implied credit risk.

Barclays emphasized that in the past six months, the credit risk of these ten companies has all increased, currently hovering near the upper bounds of their six-month volatility range.

(AI group: Six-month range comparison for current 5-year CDS)

This means that investors holding the investment grade index have passively borne substantial volatility risk from the AI sector. In addition, the basis between CDS and cash bonds for these core AI companies has turned positive, meaning the cost of buying default protection has exceeded the extra yield from holding these companies' bonds.

According to Bloomberg, this anomaly is mainly driven by institutions that do not hold the related bonds (such as equity funds and banks hedging), which are massively buying CDS to offset the vast risks from AI capital expenditure and related loans.

This kind of technical disruption in credit hedging and basis distortion is highly reminiscent of the logic seen in 2008. Back then, many institutions not holding subprime mortgage bonds (such as hedge funds and investment banks), betting on a macro downturn or risk avoidance, bought CDS as protection against default risk. This concentrated wave of “naked hedge” derivative buying drove CDS spreads extremely high, even surpassing the credit spread of the underlying bonds themselves, directly causing the CDS-cash bond basis to turn positive.

As Barclays released this report, major tech companies’ financing demands are continuously putting pressure on the market. Recently, Microsoft launched over $25 billion in bond issuance, Amazon added over $48 billion in long-term debt in a single quarter, and Broadcom plans to raise up to $21 billion early next year.

These massive financings have further fueled hedging demand in the market, pushing the CDS costs for relevant companies to historic highs.

Credit Characteristics Change for Chip Manufacturers, Spreads Widen Sharply

In this wave of credit repricing, the widening of CDS spreads for chip manufacturers has been the most pronounced.

Six months ago, CDS spreads for Broadcom, AMD, and Nvidia were still at the lowest levels in their category, around 40 basis points.

(AI group 5-year CDS, six months ago vs. now, ranked by six-month change)

However, now the CDS spreads of these three companies have leapt to the forefront, with Broadcom’s 5-year CDS surging 258% in six months, AMD rising 177%, and Nvidia up 172%. By comparison, AAA-rated Microsoft has risen only 20%.

Barclays noted in its report that as chip suppliers begin to offer loans to customers to purchase their chips (i.e., vendor financing), the credit market has started to treat these companies as lenders with highly concentrated loan books.

For instance, after banks raised concerns over Anthropic’s $6.3 billion chip deal, Broadcom stepped in with a guarantee. On this basis, Barclays recommends buying Broadcom’s 5-year CDS protection as a macro strategy to hedge against broader AI financing pressures.

Positive Basis and Hedging Demand Drive Trading Volume Surge

The shift to a positive basis between CDS and cash bonds is the most significant technical feature of the current AI credit market.

Over the past year, the basis for non-AI companies in the CDX investment grade index has remained largely negative, meaning CDS spreads are lower than bond spreads, but for the AI group, the basis has risen by about 50 basis points, turning positive. This positive basis is particularly evident among chip manufacturers and Oracle.

(The CDS-cash bond basis for the AI group is now positive, while the basis for the non-AI group remains negative)

This structural shift comes with explosive growth in trading volume. By October 23, the 4-week average weekly trading volume for large-scale cloud service providers reached about $6 billion — up about 740% year-on-year; for chip manufacturers, weekly trading volume reached $3 billion, up 1900% year-on-year.

(Trading volumes for hyperscale cloud providers and semiconductor companies’ CDS have significantly increased)

Open interest data also corroborates the continued inflow of capital. The notional value of net open interest for hyperscale cloud service providers has more than quadrupled from about $5 billion a year ago to $20 billion, while for chip manufacturers it rose from about $1.9 billion to $8.6 billion.

(Open interest in the AI group has increased from about $7 billion a year ago to over $28 billion now)

These 10 AI companies now account for nearly 14% of all outstanding single name CDS contracts for North American corporates, up sharply from 4% a year ago.

Curve Differentiation Highlights Single-Name Strategy Differences

By analyzing the spread between the 3-year and 5-year CDS curve, Barclays identified pricing anomalies for certain companies.

For example, Amazon and Google have similar 5-year CDS levels (80–81 basis points), but Amazon’s 3s5s curve (the difference between 3-year and 5-year spreads) is only 18 basis points, suggesting an unusually flat curve.

(The absolute value of the current 3s5s CDS curve, and as a percentage of 5-year CDS spread)

Barclays believes this may be due to buying pressure from Amazon’s term loan in June, and suggests buying Amazon 5-year protection or building a curve steepener position.

Subsequent financial data confirmed the need for hedging, as Amazon reported $33.5 billion in free cash flow consumption and $77.3 billion in capital expenditures for the third quarter.

As the most liquid CDS instrument in the market, Oracle’s basis is among the highest in the sample.

(Current CDS-cash bond basis vs. one-year range comparison)

Barclays suggests selling Oracle’s 5-year basis, i.e., selling the 2032-maturity bonds and selling CDS protection, to bet on basis convergence. Previously, Oracle announced an upper limit of $20 billion for additional financing over the next few years.

Additionally, Intel is the only company in the sample with a negative basis (-14 basis points) and a relatively steep curve, primarily because it has not deeply participated in supplier financing like its peers. However, after issuing weak guidance, its stock price saw its largest one-day drop since 1982.

High-Yield Market Microcosm: Soaring Cost of CoreWeave Default Protection

Outside of investment grade, CoreWeave — as the only directly related AI company CDS in the CDX High Yield Index — serves as a unique window into the credit risks of data center and new cloud service providers.

Currently, CoreWeave’s 5-year CDS is priced in “points upfront” — reaching 15.5 points, a pricing model usually reserved for distressed debt, underscoring the market’s heightened vigilance towards its risk.

(CoreWeave 5-year CDS, quoted in points upfront)

Data shows CoreWeave’s weekly CDS trading volume has risen from $32 million a year ago to $302 million, with open interest up to $850 million.

(CoreWeave weekly trading volume has risen from $32 million a year ago to $302 million, with open interest up to $850 million)

Although some analysts maintain an “overweight” rating for CoreWeave’s bonds, the up-front default protection cost as high as 15.5 points shows that the CDS market is pricing in potential default risk of its business model much more stringently.