Saturday, November 29, 2008

TED Spread - Indicator

The TED spread, or the difference between US Treasury bill and eurodollar interest rates, is an indicator of perceived credit risk in the general economy. US government Treasury bills are considered risk-free while eurodollar borrowing costs, measured by the London interbank offered rate (LIBOR), reflect the credit risk of lending to commercial banks.

When the TED spread increases it is a sign that lenders believe the risk of default on interbank loans 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 banks defaults is considered to be decreasing, the TED spread decreases. The TED spread fluctuates over time but has often remained within the range of 10 and 50 basis points (0.1% and 0.5%), at least until 2007. A rising TED spread often presages a downturn in the U.S. stock market, as it indicates that liquidity is being withdrawn.

- Clive McKeef

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