Right Said the TED Spread

Takeaway: While not yet at alarming levels, interbank lending rates are increasing - a negative, on the margin, for liquidity and counter party risk.

We’ve used this play on words before when referring to the Ted Spread.  “Right Said Fred” is an English based band formed by the brothers Richard and Fred Fairbrass in the last 1980s that is most well known for the hit single, “I’m Too Sexy.”  While following interbank lending rates isn’t exactly sexy, we’d be remiss if we didn’t highlight the recent acceleration in the Ted Spread domestically and the Euribor-OIS spread overseas.

Just as a refresher, the TED Spread is the difference between interest rates on interbank loans and short-term U.S. government debt (effectively the risk free rate).   Overtime, the TED Spread usually ranges between 10 and 50 basis points.   In the financial crisis of 2008, the TED Spread eclipsed 450 basis points.   This exceeded the previous record of 300 basis points after the Black Market crash of 1987.

An expanding TED Spread implies that liquidity is being withdrawn from the system and is therefore seen as a precursor to equity market declines.  More broadly, it is seen as an indicator of perceived risk in the general economy.  In effect, as the spread increases it is a sign that lenders believe the risk of default on interbank loans, or counterparty risk, is increasing.

In the chart below we highlight the recent movements in the TED spread and the Eurbor-OIS spread, which is the daily reference rate at which Eurozone banks offer to lend unsecured funds to other banks in the European interbank market.  Clearly, we are not yet in a danger zone for either, but both have been accelerating on a percentage basis over the past weeks.  The Eurobor-OIS spread widened by 5 basis points to 16 bps last week and the TED Spread rose 2.7 basis points to 21.4.

In part, these spreads widening have led our Financials team to turn bearish on their sector this morning.  As Sector Head Josh Steiner wrote in his Monday Morning Risk Monitor today:

“Last week's risk monitor argued for being cautiously opportunistic on the long side as the interbank risk measures remained benign, Euribor-OIS & TED Spread, in spite of the growing concern around EM market and currency risks. This week is a different story. On Friday of last week we saw the Euribor-OIS spread hockey stick higher. We also saw a notable upward move in the TED Spread. These have historically been two of the most accurate risk gauges in signaling when to move from an aggressive to a defensive posture. They're indicating fairly clearly now that the situation is deteriorating. Couple that with our quantitative line of intermediate-term support (TREND: $21.36) in the XLF being broken, and there are clear, bright-red warning signals flashing. We'll heed them until they tell a different story.”

Our Macro Team will be doing an update call on the U.S. economy on Wednesday at 11am, at which point we will dig deeper into the implications of the emergent expansions in the TED and Eurobor-OIS Spreads.  Dial in instructions will be circulated head of the call.

Right Said the TED Spread - TED Spread

Daryl G. Jones

Director of Research