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The TED spread is one of the most basic gauges of fear in the financial markets. TED stands for Treasury Eurodollar because originally it was calculated by taking the US 3 month treasury bill and subtracting it by the 3 month Eurodollar contract rate. Today the spread is calculated by taking the difference between the 3 month US T-bill rate and the 3 month LIBOR rate.
This is an important indicator because while US government issued fixed income is perceived to be “risk free” (or as close as you can theoretically get), LIBOR rates are commercial lending rates and are not. So therefore, the difference of the two isolates counterparty or default risk in the market at any point in time.
Of course, this is a generalized measure of counterparty risk across the financial markets and is not reflective of individual corporate bonds. Think of it as being a measure of credit risk the same way that the VIX is a measure of volatility. I can guarantee that it is one of the ingredients in the “Panic Button” indicator from SentimenTrader. That indicator by the way, has now shrunk back to less than 1 standard deviation away from its mean.
Right now the TED spread is showing enormous stress in the global financial markets:
Today it closed at 313 basis points which means that we have broken through the previous record set at the darkest hour of the 1987 “Black Monday” stock market crash (300 basis points). Ponder that for a second.
On the other side of things, in the summer of 2000 (remember those days?) the TED spread shrank to almost nil as everything was well with the world and everyone held hands singing songs of monetary bliss while basking in the sunshine of the “Goldilocks economy”.
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