Finance & Economics, Quantitative Analysis

And then there will be blood? Rise of TED Spreads

There will be blood might have been an excellent movie on Oil and Greed, however, the recent equity turmoil, especially in the US, is nothing about Oil. The US after decades again has become oil surplus and would be a major exporter of oil this year if I am not mistaken. 

In a series of articles published here earlier, I had predicted that 2018 would be the year of a lot of pains in the equities. One of the reasons for the decline in stock markets has also been the rising uncertainty in policies and budget deficit in the US. The markets are also pricing in the trade war between the US and China but there is so much more than meets the eye.  This year there would be at least three fed rate hikes and yet markets are buying 10 year US bond. Increase in fed rates should have been a deterrent for investors to park their money in treasuries and the recent buying bond behavior is on the back of rising risk aversion around the world. Above Source: US 10 year bond

One good way of measuring risk aversion is to carefully look at TED spreads. TED spreads is the difference between 3 months interest rate on interbank rates and 3 month T bills. The 3 month LIBOR here is the average rate at which banks in London market borrow from each other for a period of 3 months in USD. An increase in risk aversion or credit risk would lead to an increase in LIBOR since banks would want a higher rate of interest to be compensated for the risk. At the same time, an increase in risk aversion would lead to an increase in bond prices, which would reduce the yields on the bonds. An increase in 3 month LIBOR rate while a reduction in yields of 3-month treasury yields would increase the TED spreads. Therefore, an increase in TED spreads is a very good measure of rising volatility which is always been a feature of the rise in the risk premium.

Global equities especially the equity markets in the US  are readjusting their valuation and pricing models. In my opinion, the risk premium for compensation to be invested in equities has increased in the US. To be continued…


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