LIBOR, TED Spread, and Fed Funds

Even though it was a foreign term to most investors six months ago, the TED spread (3-month Libor minus 3-month Treasury) has quickly become one of the main indicators investors look to as a gauge of stress in the credit markets. While the indicator rose to historically high levels as 2007 came to a close, since the start of '08, the TED spread has been in a rapid descent, indicating that stress in the credit markets is showing signs of improvement. Today the TED spread fell to its lowest level since August 13th.

Three-month LIBOR, which is one component of the TED spread (along with 3-month Treasuries), was also highly elevated as 2007 came to a close, but since then it has also come down sharply. In fact, as of today, 3-month LIBOR closed below the Fed Funds Rate for the first time since June 2003.

Does the rapid decline in the TED Spread and 3-month LIBOR have any impact on the stock market going forward? Since 1985, this marks the 12th occurrence where LIBOR traded below the Fed Funds rate after trading above that level for at least 100 days. Below we highlight the performance of the S&P 500 one and three months following each occurrence. While the S&P 500 outperforms its average performance over the one-month period, over a three-month period, its performance is inline with average, indicating that any major positive impact on stocks is short lived.