When risk rises in the financial system most of the FX CFD traders end up getting caught by surprise, leading to unexpected losses. Flows go to safe-haven currencies until the momentum takes a new turn on the upside but in the process, retail traders are the ones hurt. The credit markets make the economy and markets function and as a result, there are several indicators traders can use to see if risks are rising and if they need to change their strategy proactively, without having to take a loss.
TED Spread
The TED Spread is the difference between the 3-month LIBOR rate and the 3-month Treasury bill rate. On one side we have the interest rate charged by banks to lend to each other, while on the other, the interest rate a government needs to pay on short-term loans. When the spread between the two widens, it is regarded as a sign of credit risk, leading to less money flowing into the financial system or the real economy.
When the COVID-19 pandemic hit the markets back in March, the TED spread spiked and the USD, yen, or the Swiss franc, were the most favored currencies.
LIBOR/OIS Spread
Another key metric for risk within the banking sector is the LIBOR/OIS Spread. This had come to the investors since the 2008 financial crisis when the gap between the two interest rates was no longer minimal. It represents the difference between LIBOR, or the short-term rate for unsecured loans, and the OIS, which is the overnight indexed swap, or a country’s central bank rate over a given period.
Banks charging higher interest rates to lend to each other as compared to the central bank benchmark rate is a key indicator for rising risk, which is why this indicator now plays such an important role for smart investors.
Lower long-end treasury yields
Accessing updated information about the above-mentioned indicators might be difficult for retail CFD traders, especially if they don’t have access to a Bloomberg terminal or other subscription-based financial source of data. That is why a simple yet very effective way to notice turbulences in the market is to look at the long-end of the yield curve.
If long-term treasury yield drop, that means investors want to protect themselves against potential short-term risks and assume that the problems will be fixed within a maximum of a few years. Did you know these indicators and if yes, were they helpful in anticipating risk rising in the FX market?