On-the-run Treasuries are the most recently issued United States government debt instruments of a specific maturity.
Understanding on-the-run Treasuries
This concept applies strictly to the debt market of the United States. When the U.S. Treasury Department auctions a new batch of securities, these newly issued notes or bonds become the on-the-run series. The older securities of that exact same maturity immediately become off-the-run Treasuries. Elephants trading in fixed income markets will notice that this cycle repeats every time the government conducts a new auction for that specific time horizon.
On-the-run Treasuries are the most frequently traded government securities in the U.S. market. They have higher liquidity and narrower bid-ask spreads compared to their off-the-run counterparts. Financial institutions prefer to use them for hedging and speculation because traders can buy and sell them in massive volumes without moving the market price. The daily trading volume for U.S. government debt is heavily concentrated in these newly issued securities.
Because of this high demand and liquidity, on-the-run Treasuries trade at a slightly higher price than older issues. This means they offer a slightly lower yield. The price difference between the new issue and the older issues is the liquidity premium. Once the U.S. Treasury auctions a newer security, the previous on-the-run security loses this premium as trading volume shifts entirely to the latest issue.
Example
Suppose an Elephant is managing a corporate bond portfolio and wants to hedge against changes in U.S. interest rates. The U.S. Treasury auctions a new 10-year note in May. These May notes are the on-the-run Treasuries. The Elephant executes trades using the May notes because the narrow bid-ask spread keeps transaction costs low. In August, the U.S. Treasury issues another batch of 10-year notes. The August notes become the new on-the-run Treasuries, and the May notes become off-the-run. The Elephant will observe the daily trading volume migrate to the August notes, while the May notes experience a slight drop in price and an increase in yield as they lose their liquidity premium.