The TED spread (i.e. three-month dol­lar LIBOR less three-month Trea­sury Bills) is a mea­sure of per­ceived credit risk in the econ­omy. This is because T-bills are con­sid­ered risk-free while LIBOR (i.e. the inter­est rate banks charge each other) reflects the credit risk of lend­ing to com­mer­cial banks. An increase in the TED spread is a sign that lenders believe the risk of default on inter­bank loans (also known as coun­ter­party risk) is increas­ing. On the other hand, when the risk of bank defaults is con­sid­ered to be decreas­ing, the TED spread narrows.

Since the TED spread’s peak of 4.65% on Octo­ber 10, 2008 the mea­sure eased con­sis­tently, but edged up from the March low (10.57 basis points) to mid June (48.64 basis points). Sub­se­quently the default risk has once again declined to the cur­rent level of 27.44 basis points.

Source: Fuller­money

The dif­fer­ence between the LIBOR rate and the overnight index swap (OIS) rate is another mea­sure of credit mar­ket stress.

When the LIBOR-OIS spread is increas­ing, it indi­cates that banks believe the other banks they are lend­ing to have a higher risk of default­ing on the loans so they are charg­ing a higher inter­est rate to off­set this risk. The oppo­site applies to a nar­row­ing LIBOR-OIS spread.

The move­ment in the LIBOR-OIS spread over the past few weeks is sim­i­lar to the TED spread and shows that risk is declining.

Source: Fuller­money

Dr. Prieur du Plessis is an investment professional with 26 years' experience in investment research and portfolio management. More than 1,200 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns, including his blog, Investment Postcards from Cape Town. He has also published a book, Financial Basics: Investment. Prieur is Chairman and principal shareholder of South African-based Plexus Asset Management, which he founded in 1995. The group conducts investment management, investment consulting, private equity and real estate activities in South Africa and a number of foreign countries. He also serves as Honorary Consul of Slovenia for South Africa, actively developing economic, cultural and scientific relations between Slovenia and South Africa. Prieur is 54 years old and live with his wife, television producer and presenter Isabel Verwey, and two children in Cape Town, South Africa. His leisure activities include long-distance running, traveling, reading, motor-cycling and scripophily. Read more from the author/contributor here.

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