On-the-Run vs Off-the-Run
On-the-Run vs Off-the-Run
The US Treasury does not issue a continuous stream of securities at every maturity. Instead, it conducts periodic auctions—one for 2-year notes, one for 3-year notes, one for 5-year notes, and so on. Each auction produces a new security, which immediately becomes the most liquid issue at that maturity. This new, most-liquid security is called on-the-run or current-coupon. The previous issues at the same maturity—issued in prior auctions—are called off-the-run or seasoned.
The distinction matters because on-the-run and off-the-run securities at the same maturity often have different yields, even though they have nearly identical risk. An on-the-run 10-year Treasury might yield 4.15%, while an off-the-run 10-year Treasury with only six months less to maturity might yield 4.25%. The off-the-run bond yields more—not because it is riskier, but because it is less liquid. Dealers and traders prefer to transact in the on-the-run security because the bid-ask spread is tighter and the volume is greater. This liquidity preference shows up as a yield premium for off-the-run bonds.
The liquidity spread between on-the-run and off-the-run varies. In calm, liquid markets (2017–2019), the spread might be only 5–10 basis points. In stressed markets (March 2020, during the pandemic panic), the spread widened to 50+ basis points as market participants shunned less-liquid securities and crowded into on-the-runs. Understanding this dynamic is important for investors who want to optimize yield or who are managing portfolios of Treasury securities.
Key takeaways
- On-the-run securities are the most recently issued at each maturity and have the highest trading volume and liquidity.
- Off-the-run securities are older issues at the same maturity; they yield more than on-the-runs because they have lower liquidity.
- The liquidity premium (the yield difference) typically ranges from 5 to 50 basis points, depending on market conditions.
- Investors can capture extra yield by holding off-the-run securities instead of on-the-runs, but with the trade-off of lower liquidity and wider bid-ask spreads.
- Central banks and large institutional investors sometimes exploit the on/off-the-run spread through relative-value trades.
Why Liquidity Matters
Liquidity is the ease with which you can buy or sell an asset without moving the price significantly. A Treasury security with high liquidity can be transacted quickly and at tight spreads. The on-the-run 10-year Treasury is the most-traded security in the world; its bid-ask spread might be just 1–2 basis points ($100–$200 per million dollars of bonds). An off-the-run 10-year Treasury, by contrast, might have a spread of 10–20 basis points because fewer market-makers are standing ready to trade it.
If you own an off-the-run bond and you need to sell it immediately, you will have to take a lower price (hitting the bid) because fewer buyers are interested. Conversely, if you buy an off-the-run bond, you pay a lower price (a higher yield) to compensate for the extra illiquidity. Over the long term, if you hold the off-the-run bond to maturity, the liquidity does not matter; you get the principal back at par. But if you need to sell before maturity, the illiquidity can cost you.
The demand for on-the-run securities comes from multiple sources. Dealers use them for hedging. Central banks hold them as reserves. Foreign governments and institutions buy them. The Federal Reserve targets on-the-run securities when conducting open-market operations. Because on-the-run securities are the benchmark reference, portfolio managers use them for hedging and for constructing the Treasury yield curve. All this demand concentrates in the on-the-run, driving down yields and tightening spreads.
The On-the-Run and Off-the-Run Spread Over Time
The spread between on-the-run and off-the-run yields is not constant. In normal market conditions, it is modest—5 to 15 basis points. But in stressed conditions, it widens dramatically. In October 2008, during the financial crisis, the spread between the on-the-run 10-year Treasury and the off-the-run 10-year Treasury widened to 30–40 basis points. In March 2020, as the pandemic panic hit, the spread again widened to 50+ basis points. Investors and dealers were so desperate for liquidity that they crowded into on-the-runs and abandoned off-the-runs.
This widening of the on/off-the-run spread is a sign of market stress. When spreads are tight (5 basis points), markets are functioning smoothly. When spreads widen significantly (40+ basis points), it signals that dealers are unwilling to intermediate or that demand for liquidity is overwhelming supply. The Federal Reserve watches these spreads closely and sometimes intervenes in the Treasury market to restore liquidity if spreads become dislocated.
For investors, watching the on/off-the-run spread is a useful gauge of market health. A widening spread is a warning sign that dealers are stressed or that market liquidity is drying up. A tightening spread is a sign of normalization and recovery. During the March 2020 panic, investors who were forced to sell illiquid positions suffered losses. This is a reminder that even Treasury securities, which are supposed to be the safest and most liquid assets in the world, can become illiquid in severe stress.
Investor Strategy: Capturing the Liquidity Premium
For individual investors with long time horizons, buying off-the-run Treasury securities can make sense. If you are building a 10-year ladder and you will hold each rung to maturity, the liquidity does not matter. You can buy an off-the-run 5-year Treasury yielding 3.5% instead of an on-the-run 5-year yielding 3.45%. Over 5 years, that extra 5 basis points of yield is real money: on a $100,000 position, 5 basis points per year is $500 per year, or $2,500 over 5 years.
The catch is that you need to be willing to hold. If you buy an off-the-run bond and then need to sell in a few years, you may face a wider bid-ask spread when you try to exit. The dealer may offer you a price that reflects not just the current yield on off-the-run bonds but also a penalty for illiquidity. You might buy an off-the-run 5-year yielding 3.5%, and when you try to sell it 2 years later (with 3 years remaining), you might be forced to accept a yield of 3.7% (giving up $200 of principal) because the market for off-the-run securities is thinner.
For this reason, the off-the-run yield premium is not pure extra income; it is partially compensation for illiquidity that you will realize if you sell before maturity. The true extra income from holding off-the-runs is the spread that persists after accounting for this exit cost.
Institutional investors and hedge funds do exploit the on/off-the-run spread. A trader might buy an off-the-run 10-year and sell (short) an on-the-run 10-year with nearly the same maturity, betting that the spread will tighten as the on-the-run rolls off and the next auction approaches. When the next on-the-run 10-year is issued, the old on-the-run becomes off-the-run, and its yield typically rises to align with other off-the-run issues. The trader profits from this tightening. But this requires leverage, active trading, and comfort with mark-to-market volatility—not suitable for most retail investors.
How Curve Construction Accounts for On/Off-the-Run Differences
When the Treasury Department and financial institutions construct the Treasury yield curve, they rely primarily on on-the-run securities because those are the most liquid and most representative of market consensus. The published yield curve is sometimes called the "on-the-run curve" because it is built from on-the-run securities.
Off-the-run securities are less frequently used in curve construction, though some sophisticated methodologies incorporate them. The reason is that off-the-run yields reflect both the term structure (the relationship between maturity and expected rates) and the liquidity premium. Mixing liquidity-distorted yields with pure term-structure yields can contaminate the curve.
For bond investors, this means the published Treasury yield curve represents the yields on the most liquid, most heavily traded securities. If you are buying securities far away from the on-the-run points (e.g., buying a 2.7-year Treasury when the on-the-runs are at 2-year and 3-year), you are moving into less-liquid territory, and you should expect to pay a small liquidity premium. This is not bad—it is just reality. Off-the-run bonds offer higher yield; the trade-off is lower liquidity.
Flowchart: On-the-Run vs Off-the-Run Decision
Historical Example: March 2020 Market Dislocations
In March 2020, when the COVID-19 pandemic hit markets, there was a severe flight to liquidity. Investors wanted cash and the safest assets. They crowded into the on-the-run Treasury market, pushing on-the-run yields down and off-the-run yields up, widening the spread to levels not seen since the 2008 financial crisis.
An investor who had bought off-the-run Treasuries in January 2020, expecting to hold them, suddenly faced a much worse bid offer if they needed to liquidate in March. The on/off-the-run spread had widened so much that it became difficult to exit off-the-run positions at anything close to fair value. The Federal Reserve responded by dramatically expanding its Treasury purchases, including off-the-run securities, and by taking other steps to restore market liquidity. Within weeks, the spread tightened again.
This episode shows that even Treasury securities can become illiquid in severe stress. For long-term buy-and-hold investors, this is not a major concern; you simply wait out the stress and hold to maturity. But for investors who might need to sell, the risk is real. Diversifying across on-the-run and off-the-run securities, and maintaining adequate cash reserves, helps manage this risk.
Next
On-the-run and off-the-run securities differ in liquidity but have nearly the same maturity and credit quality. Behind the observed yields of these coupon-bearing securities lies an even more fundamental concept: the zero-coupon yield, or spot rate. Understanding spot rates is essential for valuing bonds and comparing relative value across maturities.