Courtesy of Mish.
The TED Spread is the difference between the interest rates on interbank loans and on short-term U.S. government debt.
The “T” stands for treasuries, and “ED” is the futures symbol for the Eurodollars contract (a measure of expected interest rates in US dollars, not at all related to euros).
Investopedia defines TED Spread as The price difference between three-month futures contracts for U.S. Treasuries and three-month contracts for Eurodollars having identical expiration months.
The TED Spread is rising. So what does that mean? How does it tie into the LIBOR scandal?
For discussion, let’s take a look at the Variant Perception article More TED Spread Widening on the Way.
One of the early warning signs of the 2008 crisis was the widening in credit spreads such as the Ted spread and the Libor-OIS spread. There was a run on the shadow banking system as the credit-worthiness of many financial institutions came under suspicion in the wake of the housing crisis. Banks’ traditional forms of short-term funding such as certificates of deposit (CD) and commercial paper (CP) dried up. As a result Libor, which is supposed to reflect bank funding costs, began to rise inexorably.
Today, we are seeing some widening in the Ted spread (red line, chart below) – but for what should be predictable reasons. More onerous regulations, which are due to come into effect on October 14th, are leading to less demand for so-called prime money market funds. Given that they invest about 60% of their assets in CD and CP, this is causing bank funding costs to rise, and so Libor has been rising. The Libor-OIS spread has been widening (black line, chart below), which is reflective of tougher bank funding, but does not necessarily imply a bank-funding crisis is on the cards as this new regulation has been known about for some time. However, should Libor-OIS not stabilize then this would indicate a potential bigger problem. The Ted spread should also widen more over the next few months as money moves from prime funds to government funds, which implies higher Libor and lower UST bill yields.
LIBOR Discussion
That’s likely still not clear. Moreover there are new terms to explain for many. Stay with us for a bit, and for an interesting flashback at the LIBOR rigging scandal.
LIBOR is the “London Interbank Offer Rate”, the interest rate at which banks are willing to lend US dollars to each other, overnight. It is a stated rate, not necessarily reflective of any real transactions.
