The TED spread (an acronym for “Treasury-EuroDollar Spread”) is a key barometer for gauging global financial health, created by calculating the difference between the interest rates of the three-month London Interbank Offered Rate (LIBOR) and the three-month U.S. Treasury Bill. The background behind the LIBOR rate is that is the rate at which major international banks will lend money to one another. By comparison, the three-month U.S. Treasury Bill rate is the rate of return on U.S. government securities issued with a maturity of three months.

When the TED spread is normal, it generally hovers somewhere between 0.05 and 0.85 percentage points. When the TED spread widens, it’s a sign of increased market distress, decreased confidence in financial institutions, and an increased risk of defaults. This is because a higher LIBOR rate suggests a higher risk of default on interbank loans, while the Treasury rate remains more constant since it is perceived as “risk free.” The TED spread will often soar to disconcerting levels during economic downturns, such as those experienced during the recession of 2008, when it exceeded 4.0 percentage points.

The TED spread is a useful indicator for investors looking to identify areas of superior credit risk. Credit investors should take note of any large and sudden changes in the TED spread and use it as a reliable indicator of where to put their money. During times of market stress and economic uncertainty, the TED spread could be considered a valuable indicator of the health of the global financial system.

In conclusion, the TED spread is a valuable indicator for investors who are looking to gauge the overall financial health of the economy. Widening of the spread often indicates periods of financial difficulty, while narrowing outcomes often correspond to periods of high market confidence. While investors should pay close attention to the TED spread, it does tend to be a lagging indicator, and should not be used as the sole basis for making investment decisions.