By Davide Barbuscia

NEW YORK The cost of insuring exposure to U.S. government debt rose to fresh highs on Wednesday, as President Joe Biden and top lawmakers remained deadlocked in talks over raising the $31.4 trillion U.S. borrowing limit.

Spreads on U.S. one-year credit default swaps (CDS) - market-based gauges of the risk of a default - widened to 172 basis points, an all-time high, according to S&P Global Market Intelligence showed, up from a close of 163 on Tuesday.

The cost of insuring U.S. debt against default for five years stood at 73 basis points, up from 72 bps on Tuesday, touching the highest level since 2009.

A protracted legislative fight around the U.S. debt ceiling could lure in panicky buyers of insurance against a government default in coming weeks, as Treasury Secretary Janet Yellen said the government may be unable to meet all payment obligations as soon as June 1.

Due to the mechanics of a potential CDS payout, the probability of a default implied by the CDS could be lower than what current levels suggest, analysts said.

This is because in a potential CDS payout - after a non-payment event is determined - owners of protection typically use the cheapest debt they can find to settle the derivative contracts, and the prices of U.S. government bonds, particularly the long-dated ones, have fallen sharply after the Federal Reserve raised interest rates over the past year.

"The fact that yields have gone up so much for long-dated bonds means that the implied probability of default that we're seeing in the CDS market right now is far lower than it appears, especially relative to prior episodes," said Karl Schamotta, Chief Market Strategist at Corpay.

As of last week, the spread on one-year CDS implied a 3.9% probability that the U.S. would default, according to MSCI Research analysts. That was lower than in the probability in the 2011 debt ceiling crisis, when a protracted legislative standoff prompted Standard & Poor’s to downgrade the U.S. credit rating for the first time.

"We found a lower market-implied default probability than in 2011 ... despite much wider CDS spreads today," they said.

Still, the probability of default was double the level from two months earlier and nearly 10 times higher than at the beginning of the year, according to their analysis.

Big bond investors believe lawmakers will eventually reach an agreement, but have been cautioning that maintaining high levels of liquidity was important to withstand potential violent moves in asset prices.

(Reporting by Davide Barbuscia; Editing by David Gregorio)