During the crisis, you may remember that everyone started following the TED spread. Where one year earlier only investment professionals even knew what it was, during 2008 it seemed as though everyone and their dog were experts on all types of credit market indicators. Well, now that we haven’t seen anything in the news talking about the TED or other money market spreads for months, in a contrarian way it is probably a good time to pay attention to them.
In the chart below we have the TED, LIBOR-OIS, and Commercial Paper-T-Bills spreads overlaid. As you can see, they started to trend up a while back -- and that trend is still in force.
So is it the end? Is the United States defaulting tomorrow? No, nothing like that. Instead it is a sign that investors are starting to acknowledge that all is not rainbows and butterflies, and that there are some risks out there. At current levels, none of these spreads are saying anything other than liquidity has tightened up a bit -- but only a bit.
[Click to enlarge]
Money Market Spreads
So what to make of this? Only that we need to start getting more cautious. The Fed liquidity bull is slowing down ever so slightly as QE2 nears its end, and that may bring with it rising volatility in the markets. For now, however, the trend is up and new liquidity is being injected every few days. Consequently, we are long- and medium-term bullish on the risk trade.