TED Spread

The TED spread is the difference between the interest rates on inter-bank loans and short-term U.S. government debt ("T-bills").

TED spread is an indicator of perceived credit risk in the general economy. This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. When the TED spread increases, that is a sign that lenders believe the risk of default on inter-bank loans (also known as counterparty risk) is increasing. Inter-bank lenders therefore demand a higher rate of interest, or accept lower returns on safe investments such as T-bills. When the risk of default is considered to be decreasing, the TED spread decreases.

Below we show the history of the TED Spread dating back to 1986, along with how the market performed following similar spikes to the current one. As the results illustrate, the S&P 500's performance following extreme readings are mixed. In three out of four of the period where the TED spread spiked, the market was higher three months later. However, the one time it had a negative return was in 1987 when the market crashed.