By Kevin Muir of “The Macro Tourist” fame; reposted here with permission
Did I miss the memo that we should all become STIR traders? Over the past month, the financial pundits’ infatuation seems to have moved from VIX to LIBOR, with everyone keenly aware of each tick in the TED spread.
Here is the scary chart of the TED spread (the difference between US dollar eurodollar funding and American government treasury bills) that is being passed around.
A sudden widening of 30 basis points sure seems worrisome. After all, the TED spread represents the willingness of overseas banks to lend USD to one another. A quick move might represent stress in the financial system.
But is this move really that big of a deal? Let’s step back and look at the TED spread since the Great Financial Crisis.
Spikes up to today’s level of 55 basis points are not uncommon. In fact, we were here just a little more than a year ago.
So does that mean we should take a page out of Rosey Grier’s playbook and settle down with needlework to relax?
Well, not so fast. There is no doubt that the TED spread sometimes gives valuable clues about the state of the financial system.
Let’s back up and look at the TED spread since 1990.
A sudden rise definitely preceded both of the last two financial crises, so we shouldn’t dismiss a rise in the TED spread. Yet, the recent rise is quite subdued compared to previous widenings. If anything looks unusual, it’s the strange calmness that has enveloped the TED spread in the aftermath of the GFC.
Maybe this is just the market returning to more normal conditions with some volatility as opposed to the artificial flatness?
One of the main reasons that I am partial to taking Rosey’s advice is that although TED spreads are widening, it is somewhat of an isolated phenomenon. If there were problems in the banking system, you would expect high-yield credit to exhibit widening. Although I would argue that high-yield should widen first, you would at least expect a move coincident with the TED widening.
Yet when we look at the Bloomberg Barclays’ Global High-Yield Option Adjusted Credit Spread (the rate high-yield issuers pay over sovereigns to borrow), an interesting quirk appears.
The 2010, 2011 and 2016 TED spikes were all preceded with widenings in HY OAS. Yet this recent TED widening has seen virtually zero HY sell off.
So what’s going on?
Trump’s tax cut allowed for the repartition of US dollars held overseas by American corporations back home at a reduced rate. This means that those US dollars that were previously circulating in the Eurodollar market are headed back to US shores. This has the effect of reducing US dollar liquidity overseas. I know it’s a simple answer, but I live by the Occam’s razor school of philosophy.
Now maybe this repatriation will be the trigger that finally ignites the correction of absurdly-priced risk assets. I won’t rule that out by any means. Yet until I see other credit spreads moving in sympathy, I am going to ignore the TED spread, and get back to my needlepoint.