When reading market commentary about bond markets, you may come across terms like on-the-run and off-the-run bonds. These terms are used to distinguish between the most recently issued treasury securities of a particular maturity and older securities of similar maturities. On-the-run bonds refer to the newest issue of a specific maturity such as the 10 year treasury note currently being sold by the US Treasury. These bonds are considered the benchmark for their maturity bracket because they are the most up-to-date issuance, attracting significant demand, and offering the highest levels of liquidity. Off-the-run bonds, in contrast, are older issues that were previously on-the-run but have since been replaced by a newer issuance. While these bonds share similar maturity dates with on-the-run securities, for example, a 30 year treasury that was issued 20 years ago, meaning it has 10 years to go until maturity, the same as the newly issued 10 year treasury note. They typically have lower trading volumes since more of these bonds will now be owned by long term buy-and-hold investors, resulting in less liquidity and slightly higher yields. But what exactly is the practical relevance of this? Understanding the distinction between on-the-run and off-the-run bonds has practical significance for investors and market analysts alike. Here are two key areas to consider. First investor preferences. Many investors prefer on-the-run bonds due to their high liquidity as the most current bond issue of a given maturity on-the-run. Bonds attract high levels of demand, making them easier to trade and a narrower bid ask spread, making them less costly to trade. This liquidity advantage is particularly valuable for short term traders and institutional investors who require quick entry and exit from positions. Additionally, on-the-run, bonds serve as benchmarks in financial markets, setting a reference rate for pricing other debt instruments such as corporate bonds and mortgages. The 10 year on-the-run treasury, for instance, is a widely used reference point in financial markets. However, for other types of investors off-the-run, bonds might be a more attractive opportunity. These bonds generally yield slightly higher returns than on the run bonds due to their lower liquidity and reduced demand. For long-term investors, this higher yield can be beneficial, especially if they plan to hold the bond until maturity. Off-the-run bonds also sometimes exhibit price inefficiencies due to their lower trading volumes, presenting the potential for greater price appreciation for investors with a longer term or value oriented strategy. The second key area to consider is market analysis and portfolio management. The distinction between on-the-run and off-the-run bonds is also critical in understanding market dynamics and constructing portfolios. The yield spread between on-the-run and off-the-run bonds often reflects market sentiment. During periods of financial stress or market volatility, investors tend to gravitate toward on-the-run bonds, which are seen as more liquid assets and therefore safer. This shift in demand can drive down on-the-run yields and widen the yield spread relative to off-the-run bonds.

On the run bonds are typically used to construct the treasury yield curve, a fundamental tool for economic analysis and monetary policy. The yield curve derived from on-the-run securities provides insights into market expectations regarding growth, inflation, and interest rate trends. On-the-run bonds are preferred for yield curve construction due to their high liquidity and more consistent pricing, which means there are a more accurate reflection of current market conditions. In contrast, off-the-run bonds with their lower liquidity and potential price inefficiencies may not accurately represent the prevailing interest rate environment, making them less suitable for constructing a reliable yield curve.