Some time ago, I wrote a post about Timing The Market With Perceived Credit Risk, the idea that a TED Spread of 0.5% or higher was considered to be an elevated risk of bank loan default, while any Spread under 0.5% is considered to be normal. Another indicator for credit risk is the spread between corporate bonds and treasuries.
Yesterday the WSJ had a story titled, “The Ted Spread Is Dead, Baby. The Ted Spread Is Dead.” (Search Google for that headline.)
The TED spread just reached a level it hasn’t seen since May 2009, in the depths of the financial crisis. The reason? Because next month (October '16) there will be new rules regulating money-market funds which will make them less appealing as short-term investments for parking cash.
As a result, there is “less demand for short-term commercial debt that the funds typically invested in have become more costly to its issuers. Higher borrowing costs for the private sector generally are reflected in the rates that banks lend to each other and so Libor rises.”
Bottom line, the Ted Spread may not be the accurate gauge of financial stress it once was.
Thanks Chris - you are referring to this post http://stockmarketstudent.com/stock-market-student-blog/timing-the-market-with-perceived-credit-risk
As I said at the bottom I wasn’t sure how this new regulation would translate in terms of market timing.
However, are you sure the spread is rising for this reason? I see many risks, too many to count, at present.
Steve
I don’t see any harm including the TED spread in a composite market timer of several timing models. Just because Goldman Sachs dropped the Ted Spread from its financial conditions index, does not mean it is not going to work anymore. Did Goldman Sachs see the financial crisis coming, no of course not. So their insight now is tainted by their poor judgement in the past. Remember, everybody cooks with water, and that includes Goldman Sachs.
In general the greater the number of independent data sets or points that a model has the more accurate the model becomes as there is a greater tolerance for slightly messy data assuming thar there is a logical reason for including the extra data sets or points. As such I wouldn’t exclude the TED spread based on Goldman Sachs stating that they dropped it without detailed documentation as to what their reason for dropping it is including their criteria for utilizing or dropping all indicators. GS has a long history of saying one thing and doing another. Google gs and muppets to see a perspective on how they view their client relationships.
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