Treasury Securities
The world's deepest, most liquid market - $25 trillion and counting.
When the 'Risk-Free' Market Breaks
March 2020. The safest, most liquid market in the world stopped working.
Treasuries are supposed to be the ultimate safe haven. When stocks crash, money flows into government bonds. That's the playbook. But in March 2020, everything sold off together. Stocks, bonds, gold - even cash was scarce.
The on-the-run 10-year note - normally the most liquid security on Earth - suddenly traded 60-70 basis points rich to nearly identical off-the-run bonds. That's not a typo. Two Treasury securities with almost the same maturity and cash flows traded like they were from different planets.
Why did this happen? Leverage unwind. Hedge funds running relative value trades (buy cheap off-the-run, short expensive on-the-run) faced margin calls. They had to sell what they could sell - the on-the-runs. But dealers, hit with their own risk limits, couldn't warehouse the flow. The market broke.
The Fed stepped in with massive Treasury purchases. Spreads normalized within weeks. But the lesson remains: even the "risk-free" market has liquidity risk. Understanding Treasury market structure isn't just academic - it can save your portfolio in a crisis.
The Treasury Landscape
The U.S. Treasury issues debt across the entire maturity spectrum. Each type serves different investors and purposes:
Treasury Notes (T-Notes)
Key Characteristics
- Pay fixed coupon every 6 months
- 10-year note is the global risk-free benchmark
- Most actively traded government securities
- Primary hedging instrument for mortgage and corporate debt
- Key driver of mortgage rates and corporate borrowing costs
TIPS: Inflation-Protected Securities
Treasury Inflation-Protected Securities (TIPS) adjust their principal based on the Consumer Price Index. They're the government's answer to inflation fear.
Principal Adjustment
TIPS principal adjusts daily based on CPI-U index. When inflation rises, your principal grows.
Example: Buy $10,000 TIPS. CPI rises 3% over the year. Your principal becomes $10,300. You earn interest on $10,300, not $10,000.
Real vs Nominal Yield
TIPS yield is "real" (after inflation). Nominal Treasury yield = TIPS yield + expected inflation + risk premium.
Example: If 10Y nominal yields 4.5% and 10Y TIPS yields 2.0%, the market expects ~2.5% inflation (the "breakeven").
Deflation Floor
At maturity, TIPS pay the greater of adjusted principal or original face value. You can't lose from deflation.
Example: If cumulative deflation reduced your principal to $9,800, you still get $10,000 at maturity.
STRIPS: Zero-Coupon Treasuries
STRIPS stands for Separate Trading of Registered Interest and Principal of Securities. Dealers take a coupon-paying Treasury and "strip" it into individual zero-coupon pieces.
Why STRIPS matter: Pension funds and insurance companies love them. When you owe a specific dollar amount on a specific date (like a pension payment), buying a STRIP that matures on that date provides perfect duration matching. No reinvestment risk, no coupon timing mismatches.
On-the-Run vs Off-the-Run
The "on-the-run" Treasury is the most recently issued security at each maturity point. Everything else is "off-the-run." This distinction creates a two-tier market.
On-the-Run
- Liquidity: Best bid-offer spreads (often 1/64 for 10Y)
- Pricing: Trades rich (lower yield) vs similar maturity
- Uses: Hedging, quick trades, benchmark quotes
- Repo: Often trades "special" (cheaper to finance)
Off-the-Run
- Liquidity: Wider spreads, less depth
- Pricing: Trades cheap (higher yield) vs on-the-run
- Uses: Buy-and-hold, relative value trades
- Repo: Typically trades at general collateral rate
The typical spread: On-the-run 10Y trades 2-5bps rich to the first off-the-run. This "liquidity premium" is remarkably stable in normal markets - until it isn't.
When On-the-Run/Off-the-Run Matters
The on-the-run premium fluctuates with market stress. Study these historical examples:
Typical Conditions
Spread: 3 bpsWhat Happened
On-the-run 10Y trades 2-5bps rich to first off-the-run. This premium reflects pure liquidity value. Dealers and hedge funds arb this spread continuously.
The Trade Opportunity
Carry trade: Buy off-the-run, hedge with on-the-run futures. Earn the spread while waiting for convergence at next auction when your bond becomes even more off-the-run.
The Roll: When Issues Change
Every time Treasury auctions a new security at a given maturity, the roll happens. Yesterday's on-the-run becomes today's first off-the-run. A new bond takes the throne.
Pre-Auction
Current on-the-run 10Y trades at premium. Market anticipates new issue. Some traders start positioning for the roll.
Auction Day
New 10Y is auctioned. When-issued (WI) trading sets initial price. Primary dealers required to bid.
Settlement
New issue settles (T+1). It becomes the on-the-run. Previous on-the-run loses its liquidity crown.
Post-Roll
Old on-the-run cheapens 2-5bps. Its repo often normalizes from special to GC. Relative value cycle resets.
Why this matters: If you're long the on-the-run for its liquidity premium, you face "roll risk" when new issue arrives. Your bond cheapens. Systematic traders account for this in their carry calculations.
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Trade Examples (Simple)
Here are three real-world Treasury trades explained simply:
The On-the-Run Premium Trade
You buy $10M of the off-the-run 10Y (yielding 4.55%) and short $10M of the on-the-run 10Y (yielding 4.50%). You're "long the spread."
You repo-finance the off-the-run position (paying GC rate, say 5.30%). The short position in on-the-run requires borrowing the bond - often the on-the-run trades special, so you receive, say, 5.05%. Net financing cost is the difference: 25bps. Your spread of 5bps must outpace this cost over your holding period.
Market normalizes. The spread tightens from 5bps to 2bps as the on-the-run ages.
Duration ~8 years. 3bp spread compression = 8 x 3bps = ~0.24% gain. $10M x 0.24% = +$24,000 minus financing costs.
You bet that nearly identical bonds shouldn't trade 5bps apart. When the premium shrinks, you profit. This is classic relative value arbitrage - small edge, but low risk if duration-matched.
The TIPS Breakeven Trade
You buy $10M of 10Y TIPS at 2.00% real yield and short $10M of 10Y nominal Treasuries at 4.50%. Breakeven inflation = 2.50%.
TIPS position is financed in repo at slightly higher rate than nominals (TIPS are less liquid). The short nominal position involves paying the coupon you owe. Net carry depends on curve shape and repo rates. This trade is often slightly negative carry, betting on inflation rising.
CPI surprises higher. Realized inflation comes in at 3.5% vs 2.5% breakeven. TIPS outperform nominals.
Breakeven inflation rises from 2.50% to 3.00% (markets re-price expectations). Duration ~8yrs. 50bp move x 8 = 4% gain = +$400,000
You bet inflation would be higher than the market expected. When it was, TIPS (which protect against inflation) gained versus nominals (which don't). You isolated the "inflation surprise" factor.
The Treasury Bill Roll
You buy $100M of 13-week T-Bills at 5.25% discount yield. Every 13 weeks, you "roll" into the new 13-week bill.
No leverage needed - you're simply buying bills with cash. Money market funds and corporate treasuries do this constantly. There's no financing cost because you own the bills outright. Your return is the discount you paid at purchase.
Each quarter, your bills mature at $100 face. You use proceeds to buy the new 13-week auction at whatever rate prevails.
At 5.25% for the year, $100M x 5.25% = +$5.25M income. But if rates fall, your next roll earns less. If rates rise, you get more.
This is the simplest Treasury strategy. Park cash in T-Bills, collect the yield, reinvest at maturity. Zero credit risk, maximum liquidity. The trade-off: you have "reinvestment risk" - future rates are unknown.
Treasury Financing in Context
The U.S. government finances roughly $1 trillion in new issuance each year (on top of refinancing maturing debt). This massive supply shapes the entire fixed income universe.
Primary Dealers
24 firms are designated to bid at every Treasury auction. They're required to make markets and participate meaningfully in auctions. In exchange, they get direct access to the Fed and first look at new supply.
Auction Dynamics
Auctions are single-price (Dutch) auctions. Everyone pays the same clearing price. "Tails" (auction clearing higher yield than when-issued) signal weak demand. The market watches auction metrics like bid-to-cover ratios and dealer vs indirect bidder splits.
Supply Impact
Heavy auction weeks can temporarily cheapen the curve. Traders "make room" for new supply by selling ahead of auctions. Once supply is absorbed, prices often recover. Understanding the calendar helps time entries.
Fed Holdings
The Fed owns ~$5 trillion in Treasuries. When they buy (QE), yields fall and liquidity improves. When they reduce holdings (QT), supply to the market increases and repo rates can spike. The Fed is the elephant in the room.