Wednesday, October 8, 2008

The TED Spread

I was hoping the market would bounce back a little today. Instead, it fell off the trampoline.

NPR's excellent new Planet Money podcast interviewed veteran analyst and trader Vinny Catalano about his recent blog post, in which he explains that the key economic indices to watch are not the Dow Jones and NASDAQ, but rather the 3-month Treasury bills and the London Inter-bank Offering Rate, or LIBOR.

Another vital statistic of the credit market is the "TED spread". TED is an acronym of T-Bill and ED, the ticker symbol for the Eurodollar futures contract. The spread is the difference between the two. For example, if the T-Bill rate is 5.10% and ED trades at 5.50%, the TED spread is 40 basis points (bps). Basically, the higher the TED spread graph, the worse the credit crunch, and the crappier the economy. The TED spread fluctuates over time, but historically has remained within the range of 10 and 50 bps (0.1% and 0.5%), until 2007.

Today, the TED spread is almost 4%.

Catalano says three month T-bills are a good "panic gauge" for credit markets. He says that we want to see short-term T-bill interest rates rise, and the LIBOR fall. This would indicate that people are not fleeing from stocks to "safe havens" like T-bills. Ironically, there has been so much panicked flight out of stocks that T-bills have been paying negative yield- we're paying the government to take our money, and keep it out of the stock market. Scary.

Conversely, the LIBOR is the rate at which banks lend to each other. The LIBOR rate typically hovers around 2% in a healthy economy. Banks can make overnight loans to each other and collect between 1-2% interest, typically a zero-risk, guaranteed profit. Not anymore.

The Federal Reserve cut interest rates one-half percent today to the crazy-low rate of 1.5%. That was expected to help bring the LIBOR down, and encourage inter-bank lending, providing much needed grease to the gears of the international credit markets.

The LIBOR jumped to 4.58% (overnight rate was 5.38%). T-bills? Down, from 0.8% to 0.63%. My 401k is down 30%, year to date. The mattress is starting to look like a good investment.

Danielle, honey, Daddy's a little worried.

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