The Eurozone's version of the TED spread
Eoin Treacy's view
The TED spread refers to the spread between US 3-month LIBOR and US 3-month
Treasury bills. It is often referred to as a barometer of the perception of
risk attached to the banking sector relative to the sovereign. Its spike in
2008 confirmed that all was not well in the US financial system and its subsequent
quiescence reflects continued government intervention.
Over the last couple of years we have posted comments on the Eurozone's version of the TED spread (3-month Euro LIBOR – 3-month German yields) on a number of occasions. (Also see Comment of the Day on March 19th). However, what is currently happening with that spread is particularly worthy of mention. As the Euro Stoxx Banks Index plumbs new depths and peripheral sovereign spreads post new highs, the Eurozone's equivalent of the TED spread is contracting; falling back to test the 2009-2011 lows.
Since the perception of risk associated with the banking sector is clearly increasing, the contraction in this spread suggests significant attempts to provide the banking sector with liquidity. It is becoming increasingly obvious that Greece's solvency will be further tested over the coming months and that just about all of Spain's regions are in need of support. Meanwhile the ECB no longer accepts Greek paper as collateral and the German, Dutch and Finnish parliaments are proving recalcitrant when posed with the prospect of further capital infusions for the periphery.
The Euro has fallen swiftly to retest the psychological $1.20 area versus the US Dollar and while oversold in the short term a clear upward dynamic will be required to suggest short covering. The Euro hit a new low against the Yen this morning, extending its four-week decline. Here also a clear upward dynamic will be required to signal short covering.
The Spanish IBEX has returned to test the lows near 6000 and while oversold in the short-term a clear upward dynamic would also be required to signal short covering. Spanish 10-year government bond yields traded at 12% prior to Eurozone convergence and remain in a relatively consistent medium-term uptrend as they move through 7.5%. Spread over German Bunds, they are trading at 600 basis points. Clear and substantial intervention will be required to ease pressure on this market, while the so far elusive all encompassing solution for the entire Eurozone would be needed to reverse the trend.
While the contracting Eurozone TED spread signals the ECB is supplying the banking sector with ample liquidity, political dynamism is also required to form a solution. The baby steps approach to a federal Europe is proving too slow for the markets. The time for bold leadership to come to the fore in order to press ahead with further cohesion is swiftly approaching. Without it, Greece will almost certainly leave the currency union and severe pressure will be put on Spain and other heavily indebted countries.