The New TED Spread?

The first time that I ever got an inkling that capital markets can be very complex and sophisticated was in 1993 when I read an article about the TED spread in the Bloomberg Professional magazine, now known as Bloomberg Markets.

Before I dive into this, let me say that the Bloomberg magazine is a great resource. I have learned a lot from it over the years and I pay for a subscription for it now that I am working without a Bloomberg terminal, the magazine is free to terminal users.

If you are unfamiliar with the TED (Treasury Euro Dollar) spread, it is the spread between the price of a three month Treasury bill and the three month Euro dollar. Usually this is captured in the futures market but doesn't have to be and I have heard of some that use LIBOR futures instead of the Euro dollar. When the spread widens there is said to be more worry in global financial markets and when the spread narrows there is said to be less worry in the financial world. Specifically when there is more worry, Euro dollar is sold and t-bills are bought and the spread widens. It works in reverse when there is less to worry about. Watching the TED spread can help guide when to overweight volatility or underweight it, regardless of what you trade.

While this is all very interesting, the TED spread seems to not be utilized as it once was. A Yahoo search for the term did not yield any recent results, other than definitions. I can quickly come up with a couple of reasons why the TED spread has lost its relevance. First the creation of the Euro as a currency has reduced the role of the Euro dollar. I don't think the Euro would automatically replace the Euro dollar due to increased synchronization between the American and European economic cycles. The synchronization is a theory of mine that I have not found elsewhere yet, so I may be wrong about that.

While the TED spread has lost its luster there may be a replacement for it in the Australian dollar/Swiss franc cross rate. The Aussie, as its known, getting stronger versus the Swissee (while that is how it is known I can not vouch for the spelling) would be equivalent to a narrowing of the TED spread, meaning less concern about global financial current events, and when the Aussie weakens it would be like the TED spread getting wider. The logic here is that among industrialized nations Australia and Switzerland are at different ends of the same spectrum.

In the last six months the Aussie has weakened considerably and we have seen most world equity markets not make much progress, bond yields go down in the US, short rates rise in the UK, US, Canada, Euroland and New Zealand as yield curves have flattened. After a summer rally in the Aussie, it has broken down in the last few weeks. I find it interesting that the break down in the Aussie also coincides with the action in the S+P 500 index. The recent high for the Aussie was October 4th or 5th, just a day or two off from the SPX's recent high.

The correlation repeats itself often. My conclusion is that the AUD/CHF cross is a good tool for confirming other indicators. I am not prepared to say that it should be my primary indicator.

This is fascinating stuff, no? Maybe now it makes a little more sense why I wanted to explore Switzerland as an equity investment theme. While that did not really pan out I do think this cross rate should be followed.