TED spread
The TED spread is a financial indicator that measures the difference between the three-month London Interbank Offered Rate (LIBOR), which represents the cost of unsecured interbank lending, and the three-month U.S. Treasury bill rate, considered a proxy for risk-free borrowing.[1][2] This spread, expressed in basis points, serves as a barometer of perceived credit risk and liquidity stress in the banking sector, where a wider gap signals heightened investor anxiety about bank defaults and counterparty risk.[1][2] Calculated simply as the three-month LIBOR minus the three-month Treasury bill rate, the TED spread typically ranges from 10 to 50 basis points under normal market conditions, reflecting low credit risk premiums.[1][2] It gained prominence as a real-time gauge of financial stability, particularly during periods of economic turmoil; for instance, it surged above 100 basis points starting in August 2007 amid the subprime mortgage crisis and peaked at over 450 basis points in October 2008 after the collapse of Lehman Brothers, underscoring severe interbank lending freezes.[1][2] The acronym "TED" derives from "T" for Treasury bills and "ED" for Eurodollar deposits, which underpin LIBOR.[1] With the global phase-out of LIBOR completed by June 30, 2023, due to concerns over its reliability and past manipulations, the traditional TED spread was discontinued as an official metric by institutions like the Federal Reserve Bank of St. Louis in early 2022.[3] In its place, equivalent measures have emerged using the Secured Overnight Financing Rate (SOFR), a secured rate based on overnight repurchase agreements backed by U.S. Treasuries, such as the spread between three-month SOFR and three-month Treasury bills; these adaptations maintain the indicator's role in tracking banking sector health and financial stress indexes with high correlation to the original (approximately 0.99).[4][3]Overview
Definition
The TED spread is a financial metric that represents the difference between the interest rate on short-term U.S. government debt, typically three-month Treasury bills, and the interest rate on short-term interbank loans, historically measured by the three-month London Interbank Offered Rate (LIBOR) in U.S. dollars.[1][2] This difference quantifies the premium that banks charge each other for lending over the risk-free rate provided by U.S. Treasuries, reflecting the additional cost associated with perceived credit risk in the interbank market.[1][2] The acronym "TED" derives from its two primary components: "T" for Treasury bills, which serve as the benchmark for risk-free short-term borrowing, and "ED" for Eurodollar deposits, which represent unsecured interbank lending rates outside the U.S. but denominated in dollars, traditionally proxied by LIBOR.[1][2] As a barometer of liquidity and perceived creditworthiness in the banking sector, the TED spread widens when banks become more cautious about lending to one another due to heightened concerns over counterparty risk, indicating tighter interbank funding conditions.[1][2] It is commonly used to gauge systemic risk in the financial system, providing insights into overall market stress without relying on equity prices or other volatile indicators.[1][2]Origin
The TED spread originated in the early 1980s when futures traders at the Chicago Mercantile Exchange began monitoring the pricing differential between 3-month U.S. Treasury bill futures and 3-month Eurodollar futures contracts, which were traded in adjacent pits on the exchange floor.[5] This measure allowed traders to assess discrepancies reflecting perceived risks in short-term funding markets.[5] The acronym "TED" derives from "T," representing the 3-month U.S. Treasury bill rate, and "ED," the ticker symbol for the 3-month Eurodollar futures contract on the Chicago Mercantile Exchange, which is based on London Interbank Offered Rate (LIBOR) expectations.[2] Initially, the spread served as a straightforward indicator of stress in money markets, capturing the premium banks demanded for interbank lending over risk-free government securities.[6] Systematic tracking of the TED spread in financial data series commenced around 1986, coinciding with its first notable appearances in economic literature and market analyses.[3] By this time, it had become a recognized tool among financial analysts for evaluating liquidity and credit conditions.[7]Calculation
Traditional Formula
The traditional formula for the TED spread is calculated as the difference between the 3-month London Interbank Offered Rate (LIBOR) and the 3-month U.S. Treasury bill rate, expressed in basis points.[3][8] LIBOR represents the average interest rate at which major global banks could borrow unsecured funds from other banks in the London interbank market for U.S. dollar-denominated loans over a 3-month period.[9][10] The TED spread is computed on a daily basis, with the 3-month LIBOR rate sourced from publications by the ICE Benchmark Administration and the 3-month U.S. Treasury bill rate derived from U.S. Treasury auctions and secondary market quotations.[11] For example, if the 3-month LIBOR rate is 2.50% and the 3-month U.S. Treasury bill rate is 2.00%, the TED spread equals 50 basis points (2.50% - 2.00% = 0.50%, or 50 basis points).[3] Historical data for the TED spread, based on this formula, is available daily from 1986 onward through the Federal Reserve Economic Data (FRED) database maintained by the Federal Reserve Bank of St. Louis.[3]Modern Adaptations
The cessation of the London Interbank Offered Rate (LIBOR) on June 30, 2023, rendered the traditional TED spread calculation obsolete, as it relied on LIBOR as the interbank lending component; this is reflected in the discontinuation of the Federal Reserve Economic Data (FRED) TEDRATE series, which tracked the metric until that date.[3] In response, market participants and financial institutions have adapted the TED spread by substituting LIBOR with the Secured Overnight Financing Rate (SOFR), a benchmark based on secured overnight repurchase agreements collateralized by U.S. Treasury securities. The modern formulation uses the 3-month Term SOFR rate minus the 3-month U.S. Treasury bill rate to maintain continuity in measuring the spread between interbank funding costs and risk-free rates.[4] A key challenge in this adaptation arises from SOFR's secured nature, which lacks the unsecured credit risk premium inherent in LIBOR, potentially understating the spread during periods of heightened counterparty risk. To address this, many implementations incorporate a credit spread adjustment derived from historical differences between LIBOR and SOFR; for the 3-month tenor, the Alternative Reference Rates Committee (ARRC) recommends a fixed adjustment of 26.161 basis points, based on the five-year median spread observed prior to the transition. This adjustment can be added to the Term SOFR rate before subtracting the Treasury bill yield, ensuring the metric better captures credit dynamics akin to the original TED spread.[12] Data for the modern TED spread is sourced from official providers, with the New York Federal Reserve publishing daily Term SOFR rates and the U.S. Department of the Treasury providing auction and secondary market yields for 3-month T-bills. Financial analytics platforms such as YCharts and Bloomberg have integrated these inputs to offer updated TED spread trackers, enabling real-time monitoring post-LIBOR. For instance, in late October 2025, the 3-month Term SOFR stood at 4.29%, while the 3-month T-bill rate was 3.86%, resulting in an unadjusted spread of approximately 43 basis points.[13][14]Interpretation
Credit Risk Indicator
The TED spread serves as a key barometer for perceived credit and liquidity risks in the banking sector, capturing the premium banks demand for unsecured interbank lending over risk-free U.S. Treasury securities. A widening spread signals elevated counterparty risk, where lenders charge higher rates to compensate for potential defaults or illiquidity in the interbank market, as banks become wary of each other's balance sheets during periods of uncertainty.[15][16] In stable economic conditions, the TED spread typically ranges from 20 to 50 basis points, reflecting normal market functioning with minimal concerns over defaults or funding shortages. Spikes beyond this range, often exceeding 100 basis points, indicate acute illiquidity or heightened fears of counterparty defaults, prompting banks to hoard liquidity rather than extend credit.[16][17] Unlike credit default swap (CDS) spreads, which measure firm-specific default risks for individual institutions or entities, the TED spread provides an aggregate view of systemic credit conditions across the broader interbank lending market. This makes it particularly useful for gauging overall banking sector health rather than isolated borrower vulnerabilities.[18][19] Theoretically, the TED spread embodies the premium for unsecured lending risks in the Eurodollar market, where LIBOR reflects the cost of dollar-denominated deposits outside the U.S., exposed to interbank default probabilities without collateral backing. This premium arises from network effects in lending relationships, where fears of one bank's insolvency can cascade, leading institutions to demand greater compensation for exposure.[15][16] Despite its utility, the TED spread has limitations as a credit risk indicator, as it primarily captures risks within the traditional banking sector and unsecured interbank channels, overlooking vulnerabilities in non-bank financial institutions or shadow banking activities. Additionally, its focus on U.S. dollar markets limits its ability to reflect global variations in credit conditions across different currencies or regions.[16][20]Links to Financial Crises
The TED spread serves as a key barometer for financial stress, with rapid widenings often preceding or coinciding with crises characterized by bank runs, credit freezes, and liquidity shortages. A surge in the spread reflects heightened interbank lending risks relative to safe-haven assets, signaling deteriorating confidence in the banking system and broader economic vulnerabilities. For instance, expansions in the TED spread have historically indicated liquidity constraints and concerns over economic growth during periods of instability.[21][22] During the 1987 Black Monday stock market crash, the TED spread provided an early test of its signaling power, jumping to nearly 300 basis points in October 1987 amid the Dow Jones Industrial Average's 22.6% plunge, which exacerbated fears of systemic liquidity issues. This widening highlighted interbank caution following the unprecedented market volatility.[23] The 2008 Global Financial Crisis marked the TED spread's peak relevance, as it reached 464 basis points on October 10, 2008, triggered by the Lehman Brothers collapse and subsequent freezing of credit markets, where interbank lending virtually halted due to counterparty fears. This extreme level underscored the crisis's severity, with the spread's prior rise from August 2007 already foreshadowing banking sector troubles.[2][24] In the 2020 COVID-19 market shock, the TED spread spiked to 142 basis points by late March 2020, as pandemic-induced uncertainty halted lending and amplified dollar funding strains globally. This rapid increase mirrored liquidity evaporation similar to prior crises, though it remained below 2008 peaks. Central bank interventions, such as the Federal Reserve's liquidity injections, have an inverse relationship with the spread; for example, post-Lehman facilities in 2008 and emergency QE in March 2020 substantially narrowed it by restoring market confidence and easing funding pressures.[25][26][27]Historical Analysis
Peak Levels
The TED spread attained its record high of 458 basis points on October 10, 2008, amid the intensification of the subprime mortgage crisis, reflecting acute interbank lending stress.[28] Other significant historical peaks occurred during earlier episodes of financial turmoil, including approximately 163 basis points in early 1989 amid the savings and loan crisis, approximately 176 basis points in September 1998 following the Long-Term Capital Management collapse, and approximately 151 basis points in September 2001 during the dot-com bust aftermath.[3] More recently, the spread surged to 110 basis points on March 17, 2020, in response to the onset of COVID-19 lockdowns and widespread market panic.[3] These peak episodes generally persisted for weeks to months, frequently aligning with sharp increases in the CBOE Volatility Index (VIX) and substantial declines in major equity indices.[3] Visual representations of the data, such as those available from the Federal Reserve Economic Data (FRED) database, highlight the rapid, exponential upward trajectories of the spread during these stress periods.[3]| Event | Approximate Peak (bps) | Date |
|---|---|---|
| 1989 Savings and Loan Crisis | 163 | February 1989 |
| 1998 LTCM Collapse | 176 | September 1998 |
| 2001 Dot-Com Bust | 151 | September 2001 |
| 2008 Subprime Mortgage Crisis | 458 | October 10, 2008 |
| 2020 COVID-19 Pandemic | 110 | March 17, 2020 |