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What is the TED spread?

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What is the TED spread?

This article will introduce the leading indicator of the economic crisis, the TED spread, and review the TED spread during several major crises in history to deepen readers’ understanding of this indicator.

What is the TED spread?

TED spread is short for Treasury (Treasury) EuroDollar (European dollar) Spread (spread), which is the difference between the 3-month Eurodollar rate and the 3-month U.S. Treasury rate.

Eurodollars are U.S. dollars that are deposited in banks outside the U.S. and are not regulated by the U.S. Federal Reserve System. Such a dollar first appeared in some European banks, so it is called “Eurodollar”, but it is not limited to Europe. Its essence is “foreign dollar”. These dollars are less regulated than those in the United States, have great flexibility, and are more risky. Financial markets often use the 3-month U.S. dollar LIBOR rate Libor to represent the Eurodollar interest rate.

Financial markets generally view U.S. Treasury bills as a “safe haven” for money. Obviously, dollars deposited in banks outside the United States are more risky than U.S. Treasury bills, so Eurodollar rates are higher than U.S. Treasury bill rates, and this gap is known as the TED spread.

The TED spread can assess credit risk and also measure the liquidity of the US dollar. Why?

Because when risk aversion rises, the Eurodollar has a higher risk and a higher risk premium relative to U.S. Treasury bills, and the TED spread increases accordingly. The larger the TED spread, the tighter the dollar’s liquidity, as funds flow to safer U.S. Treasury bills. Because of this, the TED spread can measure the level of panic in the financial market and is a leading indicator of an economic crisis.

The TED spread and the economic crisis

The figure below is a comparison of the historical trend (blue) of the TED spread and the US GDP growth rate (orange). Obviously, during several major crises in history, the TED spread quickly rose. What followed was a downturn in the U.S. economy.

On “Black Monday” on October 19, 1987, the Dow plunged more than 20%, and the TED spread began to soar a few months earlier, reaching its second-highest level in history at 2.79% in November.

When the financial crisis broke out in September 2008, the TED spread hit an all-time high of 3.15%, but as early as a year earlier, the TED spread had soared above 2% and remained at a relatively high level. high level.

When the global pandemic broke out in March 2020, the TED spread, which had been below 0.7% for more than 10 years, once rose to a high of 1.34%.

Limitations of the TED spread

Since the 3-month Eurodollar rate is often represented by the 3-month U.S. dollar Libor, which has historically been manipulated by banks in London, the TED spread has also been distorted. As the LIBOR rate Libor will completely withdraw from the historical stage on June 30, 2023, the original TED spread will no longer apply.

Details: Big event in early 2022: Libor, the London interbank offered rate, begins to withdraw from the stage of history!

Recommended Reading: DailyFX Investor Education Content Collection

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