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Why SOFR–Treasury Spreads Do Not Directly Measure Credit Risk

Article Quant Q&A · Author: Lohengrin
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Summary

The document considers whether the spread between SOFR and US Treasury rates can serve as a credit-risk indicator analogous to the LIBOR–Treasury TED spread. Its central point is that a negative SOFR spread should not, by itself, be interpreted as evidence about perceived credit risk. SOFR and Treasury yields reflect different market forces, and their relative level does not provide the same signal as a benchmark that incorporates bank credit risk.

The answer contrasts the rates’ behavior during March 2020: flight-to-quality demand and Federal Reserve liquidity pushed SOFR lower, while banking credit concerns contributed to higher three-month LIBOR. It names credit-sensitive benchmark efforts such as ICE Bank Yield Index and Bloomberg BSBY as alternatives for that type of signal, while noting that BSBY was slated for discontinuation in November 2024. The discussion is brief and does not establish a universal interpretation for every spread or market regime; it cautions against treating SOFR versus Treasuries as a direct credit gauge.

Key ideas

  • A negative SOFR–Treasury spread alone does not establish a credit-risk signal.
  • SOFR and LIBOR can respond differently to liquidity conditions and banking credit concerns.
  • In March 2020, flight-to-quality flows and Federal Reserve liquidity pushed SOFR down as credit concerns lifted LIBOR.
  • Credit-sensitive benchmarks were proposed as more direct indicators of perceived bank credit risk.
  • The document notes that BSBY was scheduled to end in November 2024.

Tags

Fixed incomeUS marketsMarket microstructure
Full text
# Understanding Spread, SOFR - US Treasury


# Understanding Spread, SOFR - US Treasury












I am reading about USD LIBOR transition to SOFR (Secured Overnight Financing Rate). Here, I was reading about key differencies between both rates. I would like to bettter understand relationship between SOFR and US Treasuries.

For the LIBOR, there is e.g TED Spread (3-month LIBOR minus 3-month T-bill) that is indicator of perceived credit risk in the economy. I can easily find information about TED spread increase/decrease and how it can be interpreted.

Is there anything similar for SOFR?

In particular, I am interested in the negative spreads and its implication. For the LIBOR TED it is very rare. However, on the average SOFR should be lower then LIBOR, so it means that this should be more common with the SOFR rate.

## Answer by AKdemy (score 2, accepted)

https://quant.stackexchange.com/a/63679

This has been asked before.

I do not think there is any implication from a negative spread (certainly not from the perspective of it being an indicator of perceived credit risk or not).

Edit: There is a number of companies who seek to develop and offer a credit sensitive benchmark.

- ICE's Bank Yield Index

- Bloomberg's BSBY Index So if you desire an indicator for (perceived) credit risk, these will be the go to indices.

Why this is needed (or there is a demand for such indices) becomes clear when looking at March 2020. Flight to quality and FED liquidity pushed SOFR down, but credit concerns in banking pushed up 3m Libor.

Edit BSBY will be discontinued on November 15,2024 after a damning Iosco verdict, see Risk.net.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.