After recent market action, I was anxious to follow up on an article from last month discussing the TED spread. This article will discuss a little of this and a little of that related to the TED spread.
The June 19 article found at this link discussed the TED spread, a measure of default risk followed by some market pundits. In brief, equity markets don't like rising default risk or even perceived rising default risk, whether that risk is actually rising. That article provides the background information for the TED spread, including its previous and current method of calculation.
That article ended with the following concern. The TED spread had had been moving in a wide descending channel since last August's explosion above its typical 0.10-0.50 range (10 to 50 basis points). Just previous to the article's publication, the TED spread had dipped toward channel support and begun rising, although it hadn't yet risen into the danger zone I had identified as my personal Yikes! point.
My research was anecdotal and derived from a time period in which the TED spread's actions were already aberrant, but I had concluded that it might be dangerous for equities if the TED spread then began moving into and above the 0.90-1.00 range (90 to 100 basis points). I warned traders to be careful with equity positions if that should happen, although offering the caveat that my inability to get a feed through my charting service did not allow me to do more than a cursory presentation or study.
What's happened since that article was written that made me so anxious to do a follow-up article? From 6/18-6/23, the TED spread broke above a 0.86 resistance level and charged above 0.90. It retested on 6/23 and then surged higher, reaching a new recent high of 1.132 on 6/27.
A Bloomberg.com One-Month Chart of the TED Spread, with a One-Month Chart of the
SPX Immediately Below:
Unfortunately, since the Bloomberg charts don't allow me to add trendlines or annotations, I can't mark the salient points directly on the chart. Still, even a cursory study makes it clear that as the TED spread began breaking above its consolidation-range resistance on 6/18 and moved into and through the 0.90-1.00 zone, markets did indeed flounder.
As the TED spread was rising into what I felt was a danger zone, my research was confused by a new concern. Could the approaching June FOMC meeting be distorting the movements in the TED spread? I located articles and commentaries that suggested that it could indeed be impacted by the interest-rate environment. In addition, as I noted in a 6/25 post on the Market Monitor, the live portion of our site, one response to an article written by Paul Krugman in the NEW YORK TIMES offered another interpretation. A response by "Nick" noted that "Interpreting Interbank spreads (TED, BOR/OIS, etc.) over bank earnings season requires considerable finesse. It is comparable to interpreting the implications of high overnight equity option implied volatility the day before corporations put out earnings."
We are of course approaching earnings season for financials. Earnings season kicks off next week with Alcoa's (AA) report, but some financials will be following shortly with their reports the week of July 14-18. Financials reporting that week include US Bancorp, State Street, Wells Fargo, Merrill Lynch, JPMorgan Chase, and Citigroup, among others.
If the approaching reporting season can confuse the interpretation of the TED
spread or if professionals have switched to another type of spread such as the
BOR/OIS referenced in some articles, what do we conclude? I don't know about
you, but as I represent those of you who are self-taught in trading and economic
matters, I'm going to conclude that I can't be dogmatic about my
interpretations. Having had my conclusions confirmed by market action over the
last month, however, I know
this: for the sakes of my mother-in-law trying to
live on her investments, and all us baby boomers who will soon be doing the
same, I want the TED spread to go back down.