Ted Spread

Fixed Income · intermediate · CC-BY-4.0

The TED spread is the difference between the three-month US Treasury bill yield and the three-month LIBOR (or SOFR) rate, expressed in basis points. It is a widely used barometer of credit risk and liquidity stress in the banking system, reflecting the premium that banks charge to lend to each other in the interbank market relative to the risk-free US government rate.

Key takeaways

• A widening TED spread signals increasing stress in the banking system, as banks demand a higher premium over risk-free rates to lend to each other, reflecting heightened counterparty credit risk perception.
• In normal market conditions, the TED spread is typically 10–50 basis points; during crises, it has spiked to 350–460 bps (2008 financial crisis) and 100–150 bps (2020 COVID shock) before reverting.
• The 'TED' acronym stands for 'Treasury-EuroDollar,' reflecting its origins as the spread between T-bill futures and Eurodollar futures contracts on the CME Group.
• The TED spread served as an early warning indicator in 2007–2008, widening significantly before many other credit spreads signaled system-wide stress, providing valuable lead time for risk managers.
• With the transition away from LIBOR to SOFR, the traditional TED spread (T-bill minus LIBOR) has been replaced in many contexts by alternative interbank credit measures, including the SOFR-OIS spread and the BSBY-SOFR basis.

Explanation

The TED spread emerged as a standard financial market risk barometer in the 1980s when Treasury bill futures and Eurodollar futures began trading in organized markets. The original calculation compared T-bill futures prices directly with Eurodollar futures prices on the same delivery date, with the spread between the two reflecting the additional yield demanded by lenders in the unsecured interbank market (where Eurodollar deposits were originated) relative to the risk-free T-bill rate. As the spot LIBOR fixing replaced the futures-based measurement in common practice, the TED spread became defined as the simple difference between 3-month spot LIBOR and 3-month spot T-bill yields.

The intuitive interpretation of the TED spread as a credit risk thermometer rests on the credit quality difference between the borrowers underlying each rate. The 3-month T-bill yield is the rate at which the US government borrows, representing a near-perfect proxy for the risk-free rate (zero credit risk, ample liquidity). The 3-month LIBOR rate is the rate at which the largest international banks report they could borrow from each other in the unsecured interbank market—a rate that incorporates a premium for the credit risk of the lending banks. As bank creditworthiness deteriorates (or is perceived to), lenders demand higher LIBOR rates relative to T-bills, widening the TED spread. Conversely, in periods of abundant liquidity and bank system health, the TED spread compresses toward its minimum as the credit premium vanishes.

The historical behavior of the TED spread underscores its value as a crisis early warning indicator. During the savings and loan crisis of the late 1980s, the TED spread briefly exceeded 200 basis points as bank failures created uncertainty. During the Russian default and LTCM crisis of 1998, the TED spread spiked to approximately 130 basis points before reverting. Its most dramatic move came during the 2008 global financial crisis: the spread averaged 25–40 bps in normal conditions through 2006, began widening in August 2007 as BNP Paribas froze three money market funds with subprime exposure, reached 150 bps by early 2008, and exploded to approximately 460 basis points in October 2008 following Lehman's bankruptcy—the highest level ever recorded. This extreme TED spread indicated that the interbank market had essentially ceased functioning as banks refused to lend to each other on any terms.

For macroeconomic analysts and risk managers, the TED spread's predictive power derives from its reflection of forward-looking bank credit risk assessment. Banks that lend in the interbank market have access to information about their peers' financial conditions—their loan book quality, liquidity positions, and derivative exposures—that is not available to external investors. When insiders (the banks themselves) demand significantly higher rates to lend to each other, they are signaling awareness of risks that the broader market has not yet priced. This informational advantage makes the TED spread a useful complement to public credit ratings, equity prices, and CDS spreads as an indicator of banking system health.

The LIBOR transition has complicated the measurement and interpretation of the TED spread. LIBOR was discontinued for most currencies at end-2021 and for USD LIBOR on June 30, 2023. The natural successor spread—3-month T-bill rate versus 3-month SOFR—is structurally different because SOFR is a near-risk-free overnight secured rate that does not incorporate bank credit risk by construction. The SOFR-OIS spread is nearly zero by design, and the term SOFR rate (calculated by CME Group) reflects expectations of overnight rates rather than bank credit risk. Alternative credit-sensitive rates like AMERIBOR (developed by the American Financial Exchange) and BSBY (Bloomberg Short-Term Bank Yield Index) have been proposed as LIBOR successors that better reflect bank funding costs, but neither has achieved widespread adoption.

Formula

TED Spread = 3-Month LIBOR (or bank funding rate) − 3-Month T-Bill Yield

Example

In September 2008, as the Lehman Brothers bankruptcy crisis unfolded, the TED spread—which had been around 100 bps through the summer—began its most dramatic widening in financial history. By October 10, 2008, the TED spread peaked at approximately 460 basis points: 3-month T-bill yields fell to near zero (investors paid a premium for the safety of government paper) while 3-month LIBOR rates remained elevated above 4.5% as banks refused to lend to each other. A fixed income hedge fund monitoring this spread in August 2008 (when TED was at 100 bps and widening) could have positioned for further stress by receiving fixed on short-dated interest rate swaps (profiting from LIBOR rate declines as the Fed cut rates) while buying T-bill futures (benefiting from flight-to-quality T-bill rallies)—capturing the crisis-driven divergence between the two rates.

Related terms

Accrued Interest Basis Bond Credit Risk Default Delivery Equity Eurodollar Exchange Financial Crisis Hedge Fund Interest Rate