Wednesday, March 19, 2008

The TED Spread hits 2.0

An earlier HingeFire article talked about the TED Spread being a leading indicator for market drops caused by credit situations. Historically the TED Spread, which is the difference between U.S. Treasury bill yields and yields for Euro deposit contracts of the same maturity as represented by LIBOR, is a better warning signal than VIX when credit liquidity is tight.

Levels above 1.5 historically preceded declines in the stock market. A recent sharp increase to near 2.0 and extreme volatility of the TED spread demonstrates the market is still at risk. The credit concerns have not ended with the failure of Bear Stearns, in fact they have only increased.

Investors should still be prepared for further fall-out from the credit crunch over the upcoming weeks. It may be awhile before an “all clear” is sounded; in the mean time we can expect more bank failures, liquidity concerns, and continued negative contagion to other credit sectors. The latest word on the street is that Britain's largest mortgage lender, HBOS Plc is effectively insolvent following the earlier example of Northern Rock. The entire situation is reminiscent of Bear Stearns one week ago, the bank and regulatory officials have come out denying these “false rumors” while the bank stock dived 17% to its lowest value ever..

The TED spread indicates that the professionals have positioned themselves for a downside scenario. The current level near 2.0 should act as an alarm bell for stock market investors.