TED spread
The TED spread is the difference between the interest rates on interbank loans and on short-term U.S. government debt ("T-bills"). TED is an acronym formed from T-Bill and ED, the ticker symbol for the Eurodollar futures contract.
Initially, the TED spread was the difference between the interest rates for three-month U.S. Treasuries contracts and the three-month Eurodollars contract as represented by the London Interbank Offered Rate (LIBOR). However, since the Chicago Mercantile Exchange dropped T-bill futures after the 1987 crash,[1] the TED spread was calculated as the difference between the three-month LIBOR and the three-month T-bill interest rate. The discontinuation of LIBOR in 2021 led to its replacement by the Secured Overnight Financing Rate (SOFR) in the calculation.[2]
Formula and reading
[edit]The size of the spread was usually denominated in basis points (bps). For example, if the T-bill rate is 5.10% and ED trades at 5.50%, the TED spread is 40 bps. The TED spread fluctuated over time but generally had remained within the range of 10 and 50 bps (0.1% and 0.5%) except in times of financial crisis. A rising TED spread often presaged a downturn in the U.S. stock market, as it indicated that liquidity was being withdrawn. The discontinuation of LIBOR and its replacement by SOFR provides a similar, but not equivalent replacement, as SOFR tracks secured lending and LIBOR tracked unsecured loans.[2]
Indicator of counterparty risk
[edit]The TED spread was an indicator of perceived credit risk in the general economy,[3] since T-bills are considered risk-free while LIBOR reflected the credit risk of lending to commercial banks. An increase in the TED spread was a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. Interbank lenders, therefore, demanded a higher rate of interest, or accept lower returns on safe investments such as T-bills. When the risk of bank defaults was considered to be decreasing, the TED spread decreased.[4] Boudt, Paulus, and Rosenthal show that a TED spread above 48 basis points was indicative of economic crisis.[5]
Historical levels
[edit]Highs
[edit]The long-term average of the TED spread had been 30 basis points with a maximum of 50 bps. During 2007, the subprime mortgage crisis ballooned the TED spread to a region of 150–200 bps. On September 17, 2008, the TED spread exceeded 300 bps, breaking the previous record set after the Black Monday crash of 1987.[6] Some higher readings for the spread were due to inability to obtain accurate LIBOR rates in the absence of a liquid unsecured lending market.[7] On October 10, 2008, the TED spread reached another new high of 457 basis points.[citation needed]
Lows
[edit]In October 2013, due to worries regarding a potential default on US debt, the 1-month TED went negative for the first time since tracking started.[8][9]
See also
[edit]References
[edit]- ^ Asia Times
- ^ a b "What Are Financial Market Stress Indexes Showing?". St Louis Fed. 24 May 2022.
- ^ Bloomberg.com Financial Glossary
- ^ Mission not accomplished not yet, anyway - Paul Krugman - Op-Ed Columnist - New York Times Blog
- ^ Boudt, K.; Paulus, E.; Rosenthal, D.W.R. (2017). "Funding liquidity, market liquidity and TED spread: A two-regime model". Journal of Empirical Finance. 43: 143–158. doi:10.1016/j.jempfin.2017.06.002. hdl:10419/144456.
- ^ Financial Times. (2008). Panic grips credit markets
- ^ Bloomberg - Libor Jumps as Banks Seek Cash to Shore Up Finances
- ^ Obama Says Real Boss in Default Showdown Means Bonds Call Shots, Bloomberg.com, 11 October 2013
- ^ UBS Asset Management Taps Derivatives to Hedge U.S. Debt Risk, Bloomberg.com, 10 October 2013
External links
[edit]- Current TED Spread Quote from StockCharts.com
- Betting the Bank
- Understanding the TED spread from the Econbrowser blog