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The TED spread measures the gap between the interest rate at which the U.S. Treasury funds itself (3-month T-bills) and the interest rate at which banks lend to each other (3-month LIBOR: London Interbank Offered Rate).

The TED spread is an indicator of perceived credit risk in the general economy.  This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. When the TED spread increases, that is a sign that lenders believe the risk of default on interbank loans (also known as counerparty) is increasing. Interbank lenders therefore demand a higher rate of interest, or accept lower returns on safe investments such as T-bills. When the risk of bank defaults is considered to be decreasing, the TED spread decreases.

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