TED Spread Begins to Spike: Counterparty Risk Rises

Fear is beginning to seep into the European financial system with LIBOR rates edging up; leading to a sharp rise in the three month TED Spread (tracking 3M LIBOR against 3M US Treasuries). While nowhere near its crisis high of over 450bps, the TED Spread has enlarged to 32bps from just 19bps on May 3rd. It is now blatantly apparent, following downgrades of both Portugal and Spain and global asset sell-offs, that the crisis in the Hellenic Republic is not just a domestic or regional issue, but a global one. While the current jump pales in comparison to the spike seen during the collapse of Lehman in 2008, the TED Spread has reached levels not seen since the middle of 2009—while it was still coming off the spike caused by Lehman.

Today’s employment news from the U.S. may help to alleviate some pressure on the markets, but job gains in the U.S. will likely moderate as the year progresses as the economic recovery becomes more tepid. Additionally, we have hardly seen the end of the situation in Europe, with Portugal, Spain, and Italy next on the chopping block if the situation worsens. Yesterday, Spain’s 5Y note auction received the highest yield for the country since 2008, showing liquidity may be drying up for the nation. The situation is worse in Portugal where the country’s yield curve has begun to mirror that of Greece’s leading up to the onset of its domestic crisis.

As the chart below illustrates, for the first time this year, the TED Spread has begun to trade in correlation with the VIX, indicating fear has spread from the equities market into the intra-bank lending market, which could have significant repercussions.