Angst about the Euro­pean debt malaise reap­peared yes­ter­day, with the Greek bailout being delayed and France see­ing its debt costs rise at its first bond auc­tion of the year.

In order to gauge whether credit con­di­tions in Europe are improv­ing or wors­en­ing, I am keep­ing a close eye on the so-called TED spread, specif­i­cally the Euro­pean TED Spread. This is a handy mea­sure of per­ceived credit risk in the Euro­pean econ­omy. The spread is sim­ply the three-month euro LIBOR rate less the three-month Euro Generic Gov­ern­ment Bond rate. The Euro Generic Gov­ern­ment Bonds are con­sid­ered risk-free (if there is still such a term) while LIBOR reflects the credit risk of lend­ing to com­mer­cial banks. The TED spread there­fore reflects the pre­mium in the inter­est rate banks charge each other ver­sus the cost of bor­row­ing from the Euro­pean Cen­tral Bank (ECB).

It there­fore fol­lows that an increase in the TED spread is a sign that lenders believe the risk of default on inter­bank loans (also known as coun­ter­party risk) is increas­ing. On the other hand, the TED spread nar­rows when the risk of bank default is con­sid­ered to be decreasing.

The short– and long-term charts of the TED spread below show that the spread had increased quite sharply since June this year, but peaked with the announce­ment of the ECB’s long-term financ­ing oper­a­tions (LTRO) in Decem­ber 2011, i.e. the ECB mak­ing cheap 3-year loans to Euro­pean banks. Con­fi­dence in inter­bank lend­ing has started improv­ing, but the Euro­pean TED spread needs to show a more mean­ing­ful decline in order for a calmer envi­ron­ment to prevail.

Source: Fullermoney.com

Source: Fullermoney.com

Dr. Prieur du Plessis is an investment professional with 26 years' experience in investment research and portfolio management. More than 1,200 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns, including his blog, Investment Postcards from Cape Town. He has also published a book, Financial Basics: Investment. Prieur is Chairman and principal shareholder of South African-based Plexus Asset Management, which he founded in 1995. The group conducts investment management, investment consulting, private equity and real estate activities in South Africa and a number of foreign countries. He also serves as Honorary Consul of Slovenia for South Africa, actively developing economic, cultural and scientific relations between Slovenia and South Africa. Prieur is 54 years old and live with his wife, television producer and presenter Isabel Verwey, and two children in Cape Town, South Africa. His leisure activities include long-distance running, traveling, reading, motor-cycling and scripophily. Read more from the author/contributor here.

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