Fixed Income

US Treasurys? No thanks, I'll take bank debt

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Has bank debt become more attractive than U.S. Treasurys? That's what recent market developments indicate.

The TED spread, which measures the difference between interest rates on interbank loans and U.S. government Treasury bills, turned negative for the first time ever on Wednesday, indicating that investors are more willing to buy bank debt over U.S. Treasurys.

(Read more: Debt default damage already unfolding)

The development is yet another worrying sign of waning faith in the U.S. government, which has been shut down for 15 days. It also follows Tuesday's move by international credit rating agency Fitch Ratings to put the U.S. government's triple-A rating on 'rating watch negative'.

DC dysfunction causes Treasury yields to spike
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DC dysfunction causes Treasury yields to spike

The move in the TED underscores increasing concerns about the U.S. government's ability to pay its debts, analysts told CNBC.

"It shows that there is a concern that the possibility of a U.S. default is very clear right now," said Kelly Teoh, market strategist at IG.

"Everyone's getting out of the short-term yield and moving towards... longer term bonds. So they are still buying into it, it's just that the spike in the short-term yields is causing these inversions," she added.

Yields on front month Treasury bills have spiked over the course of the U.S. government shutdown. The yield on bills set to mature on October 31 has risen 51 basis points to 0.54 percent since October 1.

(Read more: Why a US default might not spook the Treasury market)

Bill Stone, chief investment strategist at PNC Asset Management, said the movement in short-term indicators like the TED Spread was something to be "mindful of."

"What it does show you is that there is certainly some dislocation being caused by this [the shutdown]... there is some sub-set of managers looking to kind of insure themselves," said Stone.

However, the analysts that spoke to CNBC also said that the move in the TED Spread was not a cause for alarm, as most investors ultimately expect the shutdown and debt ceiling issues to be resolved. IG's Teoh pointed out the three-month TED spread had not turned negative, reflecting that the fear in the market is only very short-term.

(Read ore: Three ways a debt default could affect you)

"Everyone's been worried for weeks but it's just now being digested by markets," said Teoh.

"The problem is we are coming close to that deadline, which although is not a hard deadline is still a deadline, so people are just unwinding their trades at the moment just to take out insurance," she added, also pointing to a recent spike in demand for credit default swaps, a form of insurance, which she said has risen tenfold, as evidence of this fear.

Although the official deadline to raise the U.S. debt ceiling is October 17, it is widely thought that the government will be able to use measures manage its interest payments for the time being.

Analysts say the markets will soon shift their focus to November 1 when the government is due to pay $67bn in social security checks, disability benefits, military pay, and interest on government bonds

"The main thing is that equity markets have not really reacted. Everyone still believes and has faith in the U.S. government to come to a conclusion," added IG's Teoh.

—By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie