Treasury Notes

 Examining Liquidity in On-the-Run and Off-the-Run Treasury Securities

By: James Clark, Chris Cameron and Gabriel Mann
5/20/2016

 

This blog post is the second in a series on fixed income markets by the Department of the Treasury to share our perspective on the available data, discuss key structural and cyclical trends, and reiterate our policy priorities.  This post examines differences in pricing between “on-the-run” and “off-the-run” Treasury securities.

In our first blog post on fixed income markets, we noted that the Treasury market—much like other secondary markets—is evolving, driven by structural and cyclical factors.  We reviewed several indicators of liquidity, and, while no individual metric is conclusive, together they paint a picture of liquidity in the Treasury market that is broadly in line with historical levels. 

This post explores how the “G-spread” (a measure of the difference in pricing between on-the-run and off-the-run securities) has evolved over time and across the curve.  First, we will provide some additional background.

As we noted previously, data underlying some liquidity metrics may only reflect a portion of transactions—namely, trading in the inter-dealer market, where the majority of trading occurs in the most recently issued Treasury securities, known as on-the-run Treasuries.  While on-the-runs are the most actively traded Treasury securities, likely accounting for more than half of total daily trading volumes, they make up less than 5 percent of outstanding marketable Treasury securities.  

The remainder of marketable Treasury debt consists of more seasoned issues, known as off-the-run Treasuries. Some market participants believe that liquidity conditions in the Treasury market have diverged between more-liquid on-the-run securities and less-liquid off-the-run securities.  If true, this divergence should result in a larger difference in pricing between the two types of securities.

In the last post, we cited a proxy for gauging this difference, the G-spread.  This spread is a measure of the discount in the price of an off-the-run Treasury security versus a hypothetical on-the-run Treasury security of the same remaining maturity and coupon.  When this spread is positive, it indicates that the off-the-run Treasury security is trading at a lower price (higher yield) than where a hypothetical, comparable new-issue Treasury security might price.  To the extent one attributes this apparent yield premium to differences in liquidity conditions, then a widening (increasing) G-spread may reflect deterioration in the liquidity of off-the-run securities relative to on-the-run securities. 

Average G-spread over time:  Since 2014, the average G-spread for Treasury notes/bonds across the curve has fluctuated and has widened modestly.  Nevertheless, as seen in the chart below, this aggregate measure remains at a fraction of levels observed in 2009 and is now largely consistent with the level from 2005-2007, a period when off-the-run Treasury securities were generally characterized as having ample liquidity.​



G-Spreads Across the Curve: Using a current snapshot, G-spreads for notes and bonds vary across the curve, and include both positive and negative values.  These differences, particularly near key on-the-run tenors, could reflect price uncertainty, diminished liquidity, or thinning trade volumes. In some cases, the magnitude and sign of these spreads can be attributed to known factors.  For example, the region of negative G-spreads around the 20-year point (circled) likely reflects large demand relative to outstanding supply for the aged 30-year bonds that are cheapest-to-deliver into the U.S. Treasury Bond futures basket.  This supply and demand imbalance can largely be attributed to Treasury’s cessation of 30-year bond issuance from 2001-2006.


As seen in the chart above (which shows notes/bonds with at least 1.75 years remaining to maturity as of April 29, 2016), the majority of Treasury securities have modest G-spreads. The modest overall level of G-spreads is made even more apparent in the chart below, which contrasts current levels with those observed during the financial crisis.

 

 
 

 

G-spread for 10-Year Sector: Several of the responses to Treasury’s recent Request for Information on the Evolution of the Treasury Market Structure argued that liquidity conditions for seasoned Treasury securities worsen as they become increasingly off-the-run.  In the chart below, we look at how the G-spreads of the three most recent issues of off-the-run 10-year notes have evolved over time.  As can be seen, the G-spreads for recent off-the-run securities appear to remain in line with those of more seasoned off-the-run securities, as well as within historical trends.  Also, as seen in the charts above, their spreads remain far below those seen during the crisis and are in line with pre-crisis levels.



G-Spread Heat Map: The preceding charts present aggregated summaries of G-spreads over time, or follow those of specific securities. An integrated picture for off-the-run pricing can be better illustrated by looking at spreads across both time and the maturity curve, as shown in the “heat-map” of historical note/bond spreads below. The red pixels below represent high average spreads, while blue pixels represent low average spreads, and green represents little to no spreads, within historical date and maturity buckets.


This perspective helps to identify fluctuations at various points on the curve, most recently in late 2015 in short maturity Treasury securities (circled) when central banks were reportedly selling large amounts of Treasury securities. Generally, though, G-spreads are consistent with historical data and far from the crisis levels characterized by the far wider variation between off-the-run and on-the-run pricing seen in 2008-2009.

In summary, the calibration and monitoring of G-spreads embedded in market prices, as illustrated above, can help round out our understanding of secondary market conditions. This metric summarizes pricing discrepancies between off-the-run and on-the-run Treasuries, and so has a direct bearing on the questions raised about off-the-run liquidity.  While the spreads between on-the-run and off-the-run Treasury securities have widened modestly at times, they remain in line with historical levels and are a fraction of the level witnessed during the crisis.  Notwithstanding these findings, G-spreads merit continued surveillance, and we will continue to evaluate options to address fluctuations in the yield curve, and manage our maturity profile with precision and flexibility.

James Clark is the Deputy Assistant Secretary for Federal Finance, Chris Cameron is a financial mathematician, and Gabriel Mann is a policy advisor in the Office of Debt Management at the U.S. Treasury Department.

Posted in:  Fixed Income
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