What Are Off-The-Run Treasuries and How Do They Work?

U.S. Treasury securities are a cornerstone of global finance, providing investors with a safe and reliable way to store value. Among these securities, “off-the-run” Treasuries play a unique role in the market, often overlooked compared to their more actively traded counterparts.

Off-the-run Treasuries offer distinct advantages and challenges that influence investor decisions. Understanding how they function is essential for navigating the fixed-income market effectively.

Distinguishing Them From On-the-Run Securities

Off-the-run Treasuries differ from on-the-run securities in their issuance status. When the U.S. Department of the Treasury auctions new bonds, notes, or bills, the most recently issued version of each maturity is “on-the-run.” These attract the highest trading volume and serve as benchmarks for pricing other fixed-income instruments. Once a new issuance replaces them, the previous ones become “off-the-run.”

This transition affects how they trade in the secondary market. On-the-run Treasuries benefit from tighter bid-ask spreads due to high demand among institutional investors and market makers. In contrast, off-the-run securities experience lower trading volumes, leading to wider bid-ask spreads and less frequent price updates. While this reduced liquidity makes them less attractive for short-term trading, it can appeal to investors focused on long-term holdings who prioritize yield over immediate tradability.

On-the-run Treasuries are widely used in repurchase agreements (repos), interest rate hedging, and as collateral for derivatives due to their superior liquidity. Off-the-run securities, while still accepted in these transactions, are more commonly held by investors seeking higher yields or those looking to hold bonds to maturity. Their pricing dynamics also make them attractive for relative value strategies, where traders exploit yield differences between similar securities.

Market Liquidity Aspects

The liquidity of off-the-run Treasuries is shaped by the investor base that typically holds them. Pension funds, insurance companies, and sovereign wealth funds often purchase these securities with the intention of holding them until maturity, reducing the frequency of secondary market transactions. This contrasts with the more active trading of on-the-run Treasuries, where hedge funds, primary dealers, and asset managers frequently engage in short-term strategies. The reduced turnover of off-the-run securities contributes to wider bid-ask spreads, making it more expensive for investors to enter and exit positions.

Market infrastructure also plays a role in how these securities trade. Electronic trading platforms such as Tradeweb and Bloomberg facilitate transactions, but off-the-run Treasuries are more commonly traded through voice brokerage, where dealers negotiate prices directly with counterparties. This reliance on over-the-counter (OTC) trading can lead to price discrepancies, as quotes may vary between market participants. The Federal Reserve’s open market operations also influence liquidity conditions, as its purchases or sales of Treasuries shift supply and demand dynamics, particularly for older issuances.

Regulatory requirements impact liquidity as well. Banks and financial institutions must comply with capital and liquidity regulations such as the Liquidity Coverage Ratio (LCR), which encourages holdings of high-quality liquid assets (HQLA). While off-the-run Treasuries qualify as HQLA, they are often considered slightly less liquid than on-the-run securities, leading banks to favor the latter for meeting regulatory thresholds. This preference reinforces the liquidity gap between the two categories.

Pricing and Yield Considerations

Off-the-run Treasuries often trade at a discount relative to on-the-run securities with similar maturities due to differences in demand and liquidity. This price discrepancy results in slightly higher yields, making them appealing to investors seeking additional return without taking on significant credit risk. The yield premium reflects the lower trading frequency and wider bid-ask spreads, compensating investors for the reduced ease of buying and selling.

Institutional investors and portfolio managers closely analyze the yield curve to identify opportunities within the off-the-run market. When the spread between on-the-run and off-the-run yields widens beyond historical norms, traders may engage in relative value strategies, such as yield curve arbitrage, to capitalize on potential mispricings. These strategies involve purchasing undervalued off-the-run securities while shorting their on-the-run counterparts, anticipating a reversion to historical pricing relationships.

The Federal Reserve’s monetary policy operations also influence pricing. During quantitative tightening, the Fed may allow older securities to mature without reinvestment, altering supply dynamics. Conversely, during quantitative easing, Fed purchases can disproportionately affect certain maturity segments, impacting the relative pricing of off-the-run bonds. These policy shifts can create temporary distortions in yield spreads, presenting opportunities for investors who monitor central bank actions closely.

Common Market Participants

The investor base for off-the-run Treasuries is diverse. Large asset managers, such as BlackRock and Vanguard, incorporate these securities into bond funds, particularly those focused on total return strategies. Since off-the-run Treasuries often offer higher yields than their on-the-run counterparts, fund managers may use them to enhance portfolio income while maintaining exposure to U.S. government debt. This approach is especially relevant in periods of declining interest rates, where locking in higher yields from older issuances can be advantageous.

Hedge funds and proprietary trading firms frequently engage in basis trades that exploit pricing inefficiencies between cash bonds and Treasury futures. These trades involve taking long positions in off-the-run securities while shorting corresponding futures contracts, aiming to profit from small pricing discrepancies. The strategy is often leveraged, with firms borrowing funds through repurchase agreements to amplify returns. While this can be lucrative, periods of market stress—such as the March 2020 liquidity crisis—have demonstrated the risks, as widening spreads force rapid unwinding of positions, exacerbating volatility.

Regulatory Landscape

The regulatory framework surrounding off-the-run Treasuries influences how they are traded, held, and reported by financial institutions. While these securities are backed by the full faith and credit of the U.S. government, various rules and oversight mechanisms shape market participation and liquidity. Regulatory bodies such as the Securities and Exchange Commission (SEC), the Federal Reserve, and the Financial Industry Regulatory Authority (FINRA) impose requirements that impact how institutions manage their Treasury holdings.

One significant regulation affecting off-the-run Treasuries is the Basel III framework, which establishes capital and liquidity requirements for banks. Under the Liquidity Coverage Ratio (LCR), financial institutions must maintain a sufficient stock of high-quality liquid assets (HQLA) to meet short-term obligations. While off-the-run Treasuries qualify as HQLA, they are often assigned a slightly lower liquidity value than on-the-run securities, influencing how banks allocate their holdings. Additionally, the Volcker Rule restricts proprietary trading by banks, limiting speculative activities involving Treasuries, though exemptions exist for market-making and hedging purposes. These regulations shape institutional demand, reinforcing the preference for more liquid securities while ensuring off-the-run Treasuries remain a viable investment option.