The TED Spread

A key market concern is determining the amount of spillover from housing and credit problems into the general economy.  This is a focal point for those analyzing the Fed, including today's beige book release,  and attempting to predict future interest rate moves.

The Wall Street Journal and CNBC featured discussions (one of many examples can be found here) of the London Interbank Offered Rate (LIBOR, pronounced LIE-bore), an instrument that was obviously new to many discussing it.  It represents the interest rate on short-term loans between commercial banks outside of the U.S.  The Eurodollar rate refers specifically to interest on dollars held outside the U.S., measured in three-month increments for various forward periods.

This topic was actually raised a day earlier by Doug Kass on RealMoney Silver, a worthwhile subscription site at TheStreet.com.

Below is a comment on this topic that I wrote today for RealMoney.  Readers of  "A Dash" might find it useful.

The financial press has discovered LIBOR, trailing by a day the observations of Doug Kass, available to RealMoney Silver subscribers. Tony Crescenzi's blog has a good discussion about why this rate has been rising.

Our readers might be interested in past LIBOR spikes. The standard measure is the TED spread - the difference between the Treasury Bill rate and the Eurodollar rate. Eurodollar futures trade at the Merc here in Chicago. It is a flexible, deep, and liquid market, permitting traders to construct interest rate positions for specific time periods in the future, and to create arbitrage positions against other credit instruments.

The TED spread is actively followed and traded. A recent article by Bespoke Investment Group includes a nice twenty-year chart of the TED spread and a table showing the returns for U.S. equities after past spikes. There are not many cases, so inferences are especially perilous. One can also see the mean-reverting character of the series.

We lack enough information to draw specific conclusions, but the key question is clear.  If elevated LIBOR rates persist, there will be some additional effect on the U.S. economy.  One article linked the  LIBOR spike to holdings at Citigroup.  What goes around, comes around.

Comments

[oldprof]

Mojave --

I'm sorry for not responding more quickly to your question, and I am glad that you found some information. I had a surprise trip with a sad mission, so I have gotten a little behind on some things.

I bought some Eurodollar futures a couple of weeks ago and took a small profit on the trade after the TAF results were announced. I did not hedge it with a TED spread type trade, but I also expect that to come in over time.

Thanks for your comment.

Jeff

[mojave]

Hmm, here's what I found: http://www.cme.com/edu/events/od/eurotedspread.html

Have a great holiday!

[mojave]

You wrote: "The TED spread is actively followed and traded." I was familiar w/ the old TED spread, long TBill futures / short ED futures (same month contract). Since the CME did away w/ T Bill futures, how is this spread currently traded?