On the run treasury

What Is On-the-Run Treasury?

An on-the-run Treasury refers to the most recently issued U.S. Treasury security of a particular maturity. These securities are a central component of the broader category of fixed-income securities and are distinct from previously issued, or "off-the-run," Treasuries. On-the-run Treasuries include newly auctioned Treasury bills, Treasury notes, and Treasury bonds. Their status as the current benchmark makes them highly liquid and frequently traded in financial markets.²⁷, ²⁸

History and Origin

The concept of an "on-the-run" Treasury naturally emerged with the systematic issuance of government debt. As the U.S. Department of the Treasury began regularly auctioning new debt securities to finance government operations, the most recent issuance for each maturity quickly became the most actively traded. This preference for the newest issues stems from their higher liquidity and their role as benchmarks for pricing other financial instruments. The U.S. Treasury market is the largest and most liquid government bond market globally, facilitating trillions of dollars in transactions annually.²⁵, ²⁶ The continuous cycle of new auctions means that a security's "on-the-run" status is temporary, transitioning to "off-the-run" as soon as a subsequent issue of the same maturity is brought to market.²⁴

Key Takeaways

• On-the-run Treasuries are the most recently issued U.S. government debt securities for a specific maturity.
• They are highly liquid and serve as benchmarks in the secondary market.
• These securities typically trade at a premium, resulting in a lower yield compared to comparable off-the-run issues.²², ²³
• Financial institutions and large investors often prefer on-the-run Treasuries due to their ease of trading.²¹

Interpreting the On-the-Run Treasury

The market for on-the-run Treasuries is often considered the deepest and most efficient segment of the U.S. Treasury market. Their high trading volume and narrow bid-ask spread indicate significant market interest and ease of execution for large trades.¹⁹, ²⁰ Investors and analysts closely monitor the yields of on-the-run Treasuries as they are used to construct the benchmark yield curve, which provides insights into market expectations for future interest rates and economic conditions. This makes them critical reference points for pricing a wide array of other financial products, from corporate bonds to mortgage-backed securities.¹⁸

Hypothetical Example

Imagine the U.S. Treasury issues a new 10-year Treasury note in February. From its auction date in the primary market until the next 10-year Treasury note is issued (perhaps in May), this February issue is considered the "on-the-run" 10-year Treasury. During this period, it will experience significantly higher trading volume and better liquidity than any older 10-year Treasury notes. Once the May 10-year Treasury note is issued, the February note then becomes an "off-the-run" security. Market participants who need to quickly buy or sell large blocks of 10-year Treasuries would primarily focus on the May issue, as it is now the on-the-run instrument.

Practical Applications

On-the-run Treasuries have several practical applications across financial markets:

• Benchmark Pricing: Their yields serve as fundamental benchmarks for pricing various other financial instruments, including corporate debt, municipal bonds, and derivatives.¹⁷
• Monetary Policy Implementation: The Federal Reserve utilizes these highly liquid securities in its open market operations to implement monetary policy. The buying and selling of Treasuries, particularly on-the-run issues, influence the supply of reserves in the banking system and the federal funds rate.¹⁵, ¹⁶
• Hedging: Traders and institutional investors often use on-the-run Treasuries for hedging interest rate risk due to their liquidity and predictable price movements.
• Trading Strategies: Some traders employ strategies that capitalize on the yield difference between on-the-run and off-the-run Treasuries, such as selling on-the-run securities short and buying off-the-run issues to profit from the liquidity premium.¹⁴ The Federal Reserve Board provides detailed explanations of its open market operations, which frequently involve the most liquid Treasury issues.¹³

Limitations and Criticisms

While highly regarded for their liquidity, on-the-run Treasuries are not without their nuances. One criticism is that their yields may not always accurately reflect the true underlying economic fundamentals due to the significant liquidity premium. This premium means that on-the-run Treasuries generally trade at a lower yield (higher price) than their off-the-run counterparts, even if their cash flows are nearly identical.¹² Research suggests that this premium might be influenced not only by buy-and-hold investors valuing liquidity but also by market intermediaries' demand to borrow and short these liquid securities for hedging purposes.¹¹ Furthermore, the concentrated trading volume in on-the-run issues can mean that off-the-run securities, while still highly safe, experience a drastic drop in trading activity, making them less efficient for large transactions.¹⁰

On-the-Run Treasury vs. Off-the-Run Treasury

The primary distinction between an on-the-run Treasury and an off-the-run Treasury lies in their recency of issuance and subsequent market characteristics. An on-the-run Treasury is the most recently auctioned security of a specific maturity, making it the current benchmark and the most actively traded. In contrast, an off-the-run Treasury refers to any previously issued security of the same maturity that is still outstanding in the market. Once a new issue is auctioned, the prior "on-the-run" security immediately becomes "off-the-run."

The differences manifest in several key areas:

The higher liquidity of on-the-run Treasuries makes them preferred for large institutional investors and those engaged in arbitrage or hedging strategies.

FAQs

What gives on-the-run Treasuries their liquidity?

On-the-run Treasuries derive their superior liquidity from being the most recently issued securities of a given maturity. This makes them the current benchmark, attracting concentrated trading activity from a wide range of market participants, including banks, institutional investors, and central banks.⁵, ⁶ Their high demand ensures there is almost always a willing buyer or seller, leading to tight bid-ask spreads and the ability to execute large trades with minimal price impact.

Do on-the-run Treasuries always offer a lower yield than off-the-run Treasuries?

Generally, yes. On-the-run Treasuries tend to trade at a premium due to their enhanced liquidity, which means investors are willing to accept a slightly lower yield for the ease of buying and selling them. This phenomenon is known as the liquidity premium. While market efficiency works to minimize significant discrepancies, this premium is a persistent characteristic.³, ⁴

How does the Federal Reserve use on-the-run Treasuries?

The Federal Reserve actively participates in the U.S. Treasury market, including trading on-the-run securities, as part of its open market operations. These operations are a key tool for implementing monetary policy. By buying or selling Treasuries, the Federal Reserve influences the amount of reserves in the banking system, which in turn impacts the federal funds rate and broader interest rates.¹, ² The liquidity of on-the-run issues makes them ideal for these large-scale transactions.