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 is now calculated as the difference between the three-month LIBOR and the three-month T-bill interest rate.
The size of the spread is 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 fluctuates over time but generally has 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 A rising TED spread often presages a downturn in the U.S. stock market, as it indicates that liquidity is being withdrawn.
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Indicator [edit]
The TED spread is an indicator of perceived credit risk in the general economy,[2] since T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. An increase in the TED spread is a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. Interbank lenders, therefore, demand a higher rate of interest, or accept lower returns on safe investments such as T-bills. When the risk of bank defaults is considered to be decreasing, the TED spread decreases.[3]
Historical levels [edit]
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The long term average of the TED has 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.[4] Some higher readings for the spread were due to inability to obtain accurate LIBOR rates in the absence of a liquid unsecured lending market.[5] On October 10, 2008, the TED spread reached another new high of 457 basis points.
See also [edit]
References [edit]
- ^ http://www.atimes.com/atimes/Global_Economy/LK25Dj01.html
- ^ Bloomberg.com Financial Glossary
- ^ Mission not accomplished not yet, anyway - Paul Krugman - Op-Ed Columnist - New York Times Blog
- ^ Financial Times. (2008). Panic grips credit markets
- ^ Bloomberg - Libor Jumps as Banks Seek Cash to Shore Up Finances
External links [edit]
- Current TED Spread Quote from CNBC
- Betting the Bank
- Understanding the TED spread from the Econbrowser blog
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