Did I miss the memo that we should all become STIR traders? Over the past month, the financial pundits’ infatuation seems to have moved from VIX to LIBOR, with everyone keenly aware of each tick in the TED spread.
Here is the scary chart of the TED spread (the difference between US dollar eurodollar funding and American government treasury bills) that is being passed around.
A sudden widening of 30 basis points sure seems worrisome. After all, the TED spread represents the willingness of overseas banks to lend USD to one another. A quick move might represent stress in the financial system.
But is this move really that big of a deal? Let’s step back and look at the TED spread since the Great Financial Crisis.
Spikes up to today’s level of 55 basis points are not uncommon. In fact, we were here just a little more than a year ago.
So does that mean we should take a page out of Rosey Grier’s playbook and settle down with needlework to relax?
Well, not so fast. There is no doubt that the TED spread sometimes gives valuable clues about the state of the financial system.
Let’s back up and look at the TED spread since 1990.
A sudden rise definitely preceded both of the last two financial crises, so we shouldn’t dismiss a rise in the TED spread. Yet, the recent rise is quite subdued compared to previous widenings. If anything looks unusual, it’s the strange calmness that has enveloped the TED spread in the aftermath of the GFC.
Maybe this is just the market returning to more normal conditions with some volatility as opposed to the artificial flatness?
One of the main reasons that I am partial to taking Rosey’s advice is that although TED spreads are widening, it is somewhat of an isolated phenomenon. If there were problems in the banking system, you would expect high-yield credit to exhibit widening. Although I would argue that high-yield should widen first, you would at least expect a move coincident with the TED widening.