Source: Wikipedia

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

Initially, the TED spread was the difference between the interest rates for three-month U.S. Treasuries contracts and the three month Eurodollars contract as represented by the London Inter Bank Offered Rate (LIBOR). However, since the Chicago Mercantile Exchange dropped T-bill futures, the TED spread is now calculated as the difference between the three-month T-bill interest rate and three-month LIBOR.

The 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 banks defaults is considered to be decreasing, the TED spread decreases. [Ed. A widening TED spread could also mean that banks want to keep whatever cash they have immediately available and on their balance sheet as cash and not a cash equivalent.]

TED is an acronym formed from T-Bill and ED, the ticker symbol for the Eurodollar futures contract. The size of the spread is usually denominated in basis points (bps). For example, if the T-Bill rate is 5.10% and ED trades at 5.50%, the TED spread is 40bps. The TED spread fluctuates over time but historically has often remained within the range of 10 and 50 basis points (0.1% and 0.5%), until 2007. A rising TED spread often presages a downturn in the U.S. stock market, as it indicates that liquidity is being withdrawn.

During 2007, the Subprime mortgage crisis ballooned the TED spread to a region of 150-200bps. On September 17, 2008, the record set after the Black Monday crash of 1987 was broken as the TED spread exceeded 300bps. Some higher readings for the spread were due to inability to obtain accurate LIBOR rates in the absence of a liquid unsecured lending market.

On September 29, 2008, after the bailout bill was unexpectedly voted down, the TED spread achieved a new high of just over 350bps. On October 2, the TED spread reached 361bps.

BY DAVID HOGBERG
INVESTOR’S BUSINESS DAILY

Treasury Secretary Henry Paulson’s massive financial bailout may be the beginning of an era of government expansion.

If Congress passes the $700 billion plan, the odds increase of greater government involvement across the economy, experts say.

“The shutting down of government involvement and the market knows best — that era is over,” said Lawrence Mishel, president of the pro-union Economic Policy Institute. “Market fundamentalism is taking a beating in policy circles and the public mind.”

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The conventional wisdom that the U.S. economy is in recession (as defined by two or more consecutive quarters of negative GDP) and future GDP revisions would bear this fact out, took it on the chin this morning with the latest revision to second quarter GDP. The Commerce Department’s new second quarter number showed that GDP grew by 3.3% in the spring, up from the 1.9% growth number originally given. While analysts had long expected the spring quarter to show a spike as government rebate checks worked their way into the broader economy, few were forecasting such a robust quarter. Corporate profits also reversed their first quarter decline and eked out a one percent gain. We also received news today that the number of new workers filing claims for unemployment benefits fell slightly last week, as was generally expected. Still, the employment picture does not look good and most analysts predict the number of unemployed to continue to rise throughout the balance of this year, into next. However, employment is a lagging indicator and it is one of the last statistics to turn around during an economic downturn.

The GDP revision is big news. Consensus estimates called for an upward revision to 2.7%, so the actual number buried this forecast. A strong increase in exports helped boost the GDP number. For the second quarter, exports rose 13.2% as opposed to the 9.2% increase originally reported. Imports also fell by a greater than expected number. Both of these developments were clearly triggered by the dollar’s relative weakness.

Surging exports may be the bright spot that helps the domestic economy avoid a statistically-validated recession this year. However, there is some concern that slowing global growth may derail this possibility. The Beijing Olympics are history and China’s infrastructure spending will revert to more normal levels, although reconstructing earthquake-ravaged regions will continue to be a spending driver for some time. The Euro Zone is clearly slowing with the GDP of many major economies now firmly in negative territory. Slowdowns in other parts of Asia and previously hot Latin American economies such as Brazil could dampen exports and choke off the one aspect of the U.S. economy showing promise at present.

Further reviewing the second quarter numbers, residential fixed investment (housing) continued to decline, but not at the meteoric rates seen in the prior three quarters. While it is hard to get too excited over what is still a pretty grim number (-15.7%) this could be a sign that a bottom is beginning to form in residential real estate—at least on a nationwide basis. There are still many markets across the country where the combination of rising foreclosures and a ponderous inventory of unsold homes and condos will take years to work off.

Business spending was a bit better than originally reported; especially noteworthy was a 13.7% increase in spending on structures. Unfortunately, the quarter’s price gauge for personal consumption was shown to jump 4.2% over the first quarter’s rise of 3.6%. Taking out food and energy, the increase was slightly below the first quarter’s number, but still reflects inflationary pressures that merit concern.

Clearly, no one is dancing in the aisles over the bulk of financial data being released these days. Rising loan delinquencies, foreclosures and unemployment bedevil the economy and make headlines far more than reports on good economic news. However, this revision is important as it does show that, despite the doom and gloom reported in the mainstream financial press, we are not technically in recession and—despite future revisions—it is unlikely that economic activity in the second quarter of 2008 will turn negative going forward.

The U.S. economy remains one of the most dynamic and resilient in the world. The rise of a more thuggish, dangerous Russia will only remind people that the American marketplace offers stability and predictability that no other economy on earth offers investors. Despite the challenges that lie ahead, it is hard to bet against the U.S. economy.

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