TED Spread

The TED spread indicates the difference between the London Interbank Offered Rate (LIBOR) and short-term government debt in the form of three-month U.S. Treasury bills (T-bills). The TED spread is expressed in the form of basis points – for instance, if the three-month T-bill rate is 1.5 percent and the LIBOR rate is 1.0 percent, then the TED spread is 50 basis points.

Originally, the TED spread measured the difference between three-month T-bills and the three-month futures contract for Eurodollars offered on the Chicago Mercantile Exchange (CME). In fact, TED is an acronym where T represents T-bills and ED stands for Eurodollars. By the mid-1980s however, the financial futures markets began adopting LIBOR rates as the standard for listing interbank rates and the TED Spread was modified to indicate the difference between three-month T-Bills and the three-month LIBOR rate.

The TED Spread is important because it reflects the perceived level of risk within the economy. This is because T-bills – which are backed by the U.S. government – are considered risk-free. The LIBOR rate on the other hand ,reflects the credit risk associated with lending to commercial banks. Therefore, the greater the gap between the two rates – that is, the higher the TED Spread – the greater the risk is perceived to be to lend money to participants in the banking system. During most of the time that the TED Spread has been tracked, the spread has ranged between 30 and 50 basis points. One notable exception was the infamous Black Monday crash of 1987 where the TED Spread approached 300 basis points, but more recent events triggered by the subprime mortgage crisis have pushed the TED Spread to new record levels surpassing 300 bps for the first time. ^[1]

References

1. ↑ MarketWatch.com