This week marks the 10-year anniversary of the beginning innings of the 2007–08 financial crisis as the TED spread began to move higher. The TED spread measures interbank lending fears by taking the difference between the three-month London Interbank Offered Rate (commonly known as Libor) and the three-month Treasury Bill (T-Bill) yield. Libor is a short-term interest rate benchmark that also measures the rate that banks charge when lending to each other in the interbank market. And both three-month Libor and the three-month T-Bill yield are heavily affected by Federal Reserve (Fed) policy. But when Libor starts to rise faster than the yield on three-month T-Bills, it’s a sign that banks are charging each other more for short-term loans, indicating potentially higher risk levels.
The TED spread started the week of August 6, 2007 at 0.44%, but had moved significantly higher to 1.02% by the end of the week (August 10, 2007), its first close above 1% since April 18, 2001. At this time the S&P 500 Index was about 6% off the then all-time highs, but would power higher to a peak of 1565.15 on October 9, 2007, before losing just over 56% and hitting its lowest daily close at 676.53 on March 9, 2009.
So where are we 10 years later? Markets are again hovering near all-time highs, and we continue to believe the ongoing pickup in U.S. growth and earnings gains can help support the stock market at current levels (see our recently released Midyear Outlook video). However, we don’t expect that current low levels of volatility will last forever (take a look at our blog from earlier today). The next crisis never looks like the last one, but when looking back, we can take heart that the TED spread and other measures of bank stress, such as credit default swap (CDS) spreads for banks, which reflect the cost of insuring against default, remain at low levels and do not suggest the presence of bank solvency fears today.
Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.
The economic forecasts set forth in the presentation may not develop as predicted.
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The TED spread is the yield differential between three-month London interbank offered rate (Libor) and the three-month U.S. T-bill rate. The European version of this measure would consider the difference between the three-month Euribor (interbank lending rate) and the three month German T-bill yield. This is considered an effective measure of the liquidity available to banks.
A credit default swap (CDS) is designed to transfer the credit exposure of fixed income products between parties. The buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product. By doing this, the risk of default is transferred from the holder of the fixed income security to the seller of the swap.
This research material has been prepared by LPL Financial LLC.
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