What Is Off the Run Bond?
An off the run bond is a previously issued government security that is no longer the most recently issued, or "on the run," bond of its particular maturity. In the realm of fixed income market securities, particularly U.S. Treasury bonds and notes, the distinction between "on the run" and "off the run" is significant due to differences in liquidity. While still actively traded, off the run bonds typically experience less trading activity compared to their newer counterparts.35 This reduced trading volume often results in a slightly lower price and, consequently, a higher yield for off the run bonds to compensate investors for the decreased liquidity.34,33 These securities play a crucial role within the broader bond market and are essential for a complete understanding of Treasury market dynamics.
History and Origin
The concept of "on the run" and "off the run" securities is intrinsically linked to the continuous issuance cycle of government debt. As governments, such as the U.S. Treasury, regularly conduct Treasury auctions to finance public spending, new securities with specific maturities are issued. Once a new security for a given maturity is auctioned, the previously issued security of that same maturity transitions from "on the run" to "off the run" status. This dynamic has been a feature of the Treasury market for decades, evolving alongside changes in market structure and trading technologies. The prominence of "on the run" issues as benchmarks for pricing other financial instruments underscores this historical evolution. Historically, primary dealers, institutions authorized to trade directly with the central bank, have played a central role in distributing newly issued Treasury securities, which become "on the run" upon issuance.,32 The continuous flow of new issues and the subsequent aging of existing ones naturally created the "off the run" category, with their liquidity characteristics evolving over time as market microstructure changed, moving from over-the-counter (OTC) voice execution towards more electronic, centralized trading.31,30 A Federal Reserve Bank of New York staff report highlights the evolution of Treasury market liquidity from 1991 to 2021, showing how various factors, including the electronification of trading, have impacted bid-ask spreads and market depth.29
Key Takeaways
- An off the run bond is a previously issued government security that is no longer the most current issue of its kind.
- Off the run bonds typically exhibit lower liquidity compared to their on the run counterparts, meaning they may be less actively traded.
- To compensate for this reduced liquidity, off the run bonds often trade at a slightly lower price, leading to a higher yield for investors.
- These bonds are primarily traded in the secondary market, through broker-dealers, rather than directly from the government.
- Investors and financial institutions may utilize off the run bonds for purposes such as portfolio management, yield enhancement, or relative value strategies.
Interpreting the Off the Run Bond
Interpreting an off the run bond primarily involves assessing its yield spread relative to comparable on the run bonds, and understanding the implications of its liquidity premium. Because off the run bonds are less actively traded, they generally command a higher yield to compensate investors for the potential difficulty or cost of selling them quickly. This higher yield is often referred to as a liquidity premium.28
Factors influencing the pricing of an off the run bond include prevailing interest rates, the bond's remaining maturity, and broader market supply and demand dynamics. When interest rates rise, new bond issues come to market with higher yields, making older, existing bonds (including off the run bonds) less attractive and causing their prices to fall.27,26 Conversely, falling interest rates can increase the value of existing off the run bonds. Additionally, the specific characteristics of the bond, such as its coupon rate and time until maturity, contribute to its fair value. Market participants, including institutional investors and traders, frequently analyze these factors to determine attractive entry and exit points for off the run bonds.
Hypothetical Example
Consider a scenario involving two U.S. Treasury notes, both with a 10-year maturity.
In January, the U.S. Treasury auctions a new 10-year note, which immediately becomes the "on the run" 10-year note. Due to its status as the most recently issued and highly liquid security, it trades actively with a relatively tight bid-ask spread. Let's assume it is priced to yield 4.00%.
Three months later, in April, the U.S. Treasury conducts another auction for a new 10-year note. This new issue then becomes the "on the run" 10-year note. The 10-year note issued in January now becomes an off the run bond.
Because investor and dealer focus shifts to the newly issued on the run note, the off the run bond issued in January will likely experience reduced trading volume and slightly wider bid-ask spreads. To attract buyers given its comparatively lower liquidity, the market will price this off the run bond at a slightly higher yield, perhaps 4.05% or 4.10%, assuming all other factors remain constant. An investor interested in maximizing yield and willing to accept slightly less liquidity might consider purchasing this off the run bond instead of the new on the run bond.
Practical Applications
Off the run bonds are used by a variety of market participants for distinct purposes within the financial markets.
- Yield Enhancement: For investors seeking to maximize their income, off the run bonds can offer a slight yield advantage over their more liquid on the run counterparts. This is particularly appealing to buy-and-hold investors who intend to hold the bond until bond maturity and are less concerned with short-term trading liquidity.
- Relative Value Trading and Arbitrage: Experienced traders and hedge funds often engage in relative value strategies and arbitrage by exploiting temporary mispricings between on the run and off the run bonds. If the yield differential, or liquidity premium, becomes unusually wide or narrow, opportunities may arise to profit from the expected convergence of these yields.25
- Duration and Convexity Management: Portfolio managers use off the run bonds to fine-tune the duration and convexity of their bond portfolios. Since off the run bonds span a wider range of issuance dates and remaining maturities, they offer more granular control over a portfolio's interest rate sensitivity.
- Monetary Policy and Central Bank Operations: While central banks, like the Federal Reserve, typically focus their open market operations on on the run securities, they may, in times of market stress, purchase off the run bonds to inject liquidity into the broader fixed income market. For example, during periods of quantitative easing (QE), central banks expand their balance sheets by purchasing large quantities of Treasury securities, which can include both on-the-run and off-the-run issues, to influence long-term interest rates and market functioning.24,23,22,21
Limitations and Criticisms
While off the run bonds offer potential advantages, they come with notable limitations and criticisms, primarily centered on their reduced liquidity. The lower trading volume means that it can be more challenging to buy or sell a significant quantity of off the run bonds without impacting their price, leading to what is known as higher price impact.20 This illiquidity translates into wider bid-ask spreads, increasing the transaction costs for investors.19,18
The decreased liquidity of off the run bonds can become particularly problematic during periods of market stress or volatility. In such environments, the capacity of the market to smoothly handle large trading flows diminishes, and the bid-ask spreads for less liquid securities, including off the run Treasuries, can widen significantly.17,16 This heightened liquidity risk means investors might be forced to sell these bonds at a larger discount than anticipated if they need to raise cash quickly. Critics also point out that valuing off the run bonds can be more complex due to their less active trading. While on the run yields serve as clear benchmarks, determining the "fair value" of an off the run bond often involves more subjective assessments of its relative illiquidity and specific market conditions, potentially leading to greater pricing discrepancies.15 Concerns about the liquidity of the U.S. Treasury market, particularly for off the run issues, have attracted increased attention from regulators and market participants, especially following episodes like the market disruptions in March 2020.14,13,12
Off the Run Bond vs. On the Run Bond
The primary distinction between an off the run bond and an on the run bond lies in their recency of issuance and, consequently, their market liquidity.
| Feature | On the Run Bond | Off the Run Bond |
|---|---|---|
| Issuance Status | Most recently issued security of a given maturity. | Any previously issued security of the same maturity. |
| Liquidity | Highly liquid; actively traded.11 | Less liquid; traded less frequently.10 |
| Trading Venue | Often trades on electronic platforms. | Primarily trades in the over-the-counter (OTC) market, sometimes via phone.9,8 |
| Bid-Ask Spread | Generally tighter.7 | Generally wider.6 |
| Price | Typically trades at a higher price.5 | Typically trades at a slightly lower price.4 |
| Yield | Generally offers a lower yield.3 | Generally offers a slightly higher yield.2 |
| Benchmark Status | Often used as a benchmark for pricing other bonds. | Less frequently used as a benchmark. |
On the run bonds are the current benchmark securities for their respective maturities, attracting the most trading volume due to their freshness and perceived relevance for hedging and price discovery. This high demand and limited fixed supply for on the run Treasuries tend to push up their prices and lower their yields. In contrast, off the run bonds, while still U.S. Treasury obligations with the same fundamental credit quality, see reduced trading activity once a newer issue replaces them. This decreased demand leads to a lower price and a relatively higher yield, compensating investors for the reduced ease of trading.1 While both are fundamental components of the bond market, their differing liquidity profiles shape their utility for various investors and trading strategies.
FAQs
What does "off the run" mean for a bond?
"Off the run" refers to a government bond or note that was previously the most recently issued security of its type but has since been replaced by a newer issue. It's essentially an older, seasoned bond within the same maturity bucket.
Why are off the run bonds less liquid?
Off the run bonds are less liquid because market participants, particularly large institutional investors and traders, tend to focus their trading activity on the most recently issued, "on the run" securities. This concentration of liquidity on new issues means older issues receive less attention and trade less frequently.
Do off the run bonds offer a higher yield?
Yes, off the run bonds typically offer a slightly higher yield compared to on the run bonds of similar maturity. This higher yield serves as a "liquidity premium," compensating investors for the reduced trading activity and potentially wider bid-ask spreads associated with these securities.
Where can off the run bonds be bought or sold?
Off the run bonds are primarily traded in the over-the-counter (OTC) market through broker-dealers. Unlike new issues that can be purchased directly from the U.S. Treasury via TreasuryDirect, off the run bonds are bought and sold among investors in the secondary market.
Are off the run bonds riskier than on the run bonds?
In terms of credit risk, off the run U.S. Treasury bonds carry the same minimal credit risk as on the run Treasuries, as both are backed by the full faith and credit of the U.S. government. However, off the run bonds do carry higher market risk in terms of liquidity, meaning they may be harder to sell quickly without affecting their price, especially during periods of market stress.