Treasury Liquidity Microstructure: On-the-Run Premiums & Depth

Introduction

Treasury liquidity microstructure examines how trades, quotes, and dealer balance sheets interact in the U.S. Treasury market. It explains why the most recently issued Treasuries, called on-the-run, trade differently from older off-the-run issues, and how depth and price impact reveal funding constraints and shifting risk regimes.

Why does this matter to you as an investor or rates trader? Liquidity in Treasuries determines execution cost, hedging efficiency, and the fairness of yield signals you use for portfolio decisions. Do you know when a small size trade will move the market or when dealer inventory limits make a liquid-looking benchmark less reliable?

In this article you will learn what on-the-run premiums are, how to measure depth and liquidity, which data sources and indicators to monitor, and how to interpret changes across normal and stressed regimes. You will also see concrete calculation examples and practical monitoring workflows you can apply to portfolios or trading strategies.

Key Takeaways

• On-the-run premiums quantify scarcity and convenience; they are usually a few basis points in normal times and widen sharply under funding stress.
• Depth metrics combine quoted sizes and price impact; both instantaneous depth and resilience after shocks matter for execution risk.
• Dealer balance sheet constraints and repo market stress drive regime changes, causing off-the-run spreads and specialness to spike.
• Monitor a mix of direct market microstructure data and macro funding indicators for early warnings, including quote sizes, Amihud-like impact, ON RRP usage, and GC repo rates.
• Combine automated alerts on spreads and depth with periodic manual checks of primary dealer reports to separate structural from temporary dislocations.

On-the-Run vs Off-the-Run: Definitions and Mechanics

On-the-run Treasuries are the most recently issued securities in a given maturity bucket. They function as the market benchmark and attract the most liquidity. Off-the-run are older issues with the same approximate maturity but less liquidity and secondary market attention.

The on-the-run premium equals the yield difference between an on-the-run security and a comparable off-the-run issue. It reflects convenience, dealer inventory preference, and hedging demand. In calm markets that premium is typically small, often one to five basis points at the 10-year area. Under stress the premium can jump into double digits.

Why premiums exist

• Benchmark demand, because investors and asset managers prefer the easiest to trade security for hedging and cash management.
• Dealer intermediation costs, since dealers concentrate inventory in on-the-run paper to facilitate two-way markets.
• Funding and settlement convenience, because repo specialness and financing terms sometimes favor one CUSIP over another.

Depth Metrics: What to Measure and Why

Depth describes how much notional you can trade at or near the quoted price without moving the mid. It is the most direct indicator of execution risk. There are multiple operational definitions you can use depending on data access.

Practical depth measures

1. Quoted depth at best bid and ask, often shown as size at the top of book. This is immediate and easy to monitor.
2. Aggregated top-of-book depth across N levels, for example depth within 1 basis point of mid across the first five levels.
3. Depth-weighted spread, the effective spread adjusted by the available size at each price level.
4. Price impact per notional, measured as basis points moved per $100 million traded. You can estimate this empirically with intraday trades.
5. Amihud-style illiquidity: average absolute return divided by dollar volume, which links volatility to traded value.

All these measures give different views. Quoted depth is fast but can be stale. Aggregated depth captures more of the book but requires level 2 data. Price impact ties directly to execution cost and is most actionable for trading sizing.

How Funding Constraints and Risk Regimes Show Up

Funding conditions drive liquidity regime shifts. When repo rates widen or dealer balance sheets are constrained, dealers scale back intermediation. That reduces depth, increases price impact, and widens on-the-run premiums.

Key drivers and indicators

• Broker-dealer balance sheet usage, seen in primary dealer net positions and the size of the Fed's SOMA holdings.
• Repo specialness and secured funding spreads, including general collateral rates versus special repo levels and SOFR spreads.
• ON RRP uptake and Treasury General Account changes, which affect cash available to dealers and money market flows.
• Implied volatility and cross-asset risk-off signals, which raise margins and reduce willingness to warehouse inventory.

As a rule of thumb, when GC repo rates spike relative to OIS or ON RRP usage surges, expect depth to fall and on-the-run premiums to widen. Those moves can precede large yield moves in less liquid off-the-run issues.

Real-World Examples and Calculations

Example 1, computing an on-the-run premium: suppose the on-the-run 10-year yield is 1.50 percent and a nearby off-the-run 10-year is 1.46 percent. The on-the-run premium equals 4 basis points. If a risk-off event increases dealer funding costs, that premium might widen to 12 basis points within a day, signaling reduced willingness to intermediate off-the-run paper.

Example 2, depth and price impact: imagine quoted best-bid size is $50 million and best-offer is $60 million at 1 basis point from mid. If a $200 million sell order hits the market and moves the mid 6 basis points, the realized price impact is 6 basis points per $200 million or 3 bps per $100 million. You can use that metric to size trades and choose execution venues.

Example 3, Amihud illiquidity: compute daily absolute change in mid yield divided by daily dollar volume in that CUSIP. Average that over a week to smooth noise. If Amihud rises from 0.00002 to 0.00008, liquidity has deteriorated fourfold, which should trigger a review of hedging plans and risk limits.

You can also track ETF proxies for liquidity. For example $TLT and $IEF will reflect broader Treasury moves and can show large flows when underlying microstructure is stressed, but they smooth away CUSIP-level specialness and are not substitutes for direct Treasury depth metrics.

Monitoring Framework: Data, Alerts, and Workflows

Set up a monitoring stack that blends market microstructure data with macro funding indicators. Automated alerts save time and catch fast regime changes. You need both tick-level and end-of-day checks.

Suggested indicators to monitor continuously

• Best-bid and best-offer sizes on the benchmark on-the-run and the nearest off-the-run, with percentage changes and absolute thresholds.
• On-the-run premium in basis points, updated intraday and averaged over 15 minutes, 1 hour, and 1 day.
• Price impact per notional estimated from recent trades, scaled to your typical trade size.
• GC repo rates, special repo levels, ON RRP usage, and primary dealer net long or short positions reported by the NY Fed.
• SOFR-OIS and term funding spreads as early warnings of funding stress.

Operational workflow example: set an alert when the on-the-run premium widens more than 5 basis points from the 30-day average and when average quoted depth drops by 50 percent. When both triggers hit, escalate to active risk management and reduce large unhedged trades in off-the-run CUSIPs until conditions normalize.

Common Mistakes to Avoid

• Focusing only on quoted spreads. Quote sizes and price impact matter more for execution. Always combine spread observation with depth and trade prints.
• Using ETFs like $TLT as direct substitutes for CUSIP liquidity. ETFs mask specialness and intraday microstructure nuances. Use them for flow context not for execution sizing.
• Ignoring dealer balance sheet signals. On-the-run premiums can widen because dealers are out of capacity not because of credit risk. Monitor balance sheet metrics and repo markets.
• Relying on a single time window. Liquidity regimes shift quickly. Use multi-horizon measures and require confirmation across indicators before changing long-term allocations.
• Misreading short spikes as regime shifts. Short-lived volatility happens. Use persistent changes and multi-indicator confirmation to distinguish transient noise from structural deterioration.

FAQ

Q: How often should I compute on-the-run premiums?

A: Compute intraday on short windows such as 15-minute averages for trading use, and store 1-hour and daily averages for trend analysis. The intraday view catches sudden funding events while daily measures help identify regime shifts.

Q: Which market depth metric is best for sizing a $100 million trade?

A: Use price impact per notional estimated from recent trades in the same CUSIP and adjusted for current quoted depth. If you lack trade history, aggregate depth within 1 basis point of the mid is a conservative proxy.

Q: Can on-the-run premia predict broad yield moves?

A: They can signal shifts in market functioning but do not alone predict direction of the yield curve. A widening premium points to reduced liquidity and higher execution costs which could amplify moves when directional pressure arrives.

Q: What public data sources should I watch daily?

A: Monitor primary dealer reports from the NY Fed, H.4.1 treasury and balance sheet releases, ON RRP usage, GC repo rates, and TRACE or Tradeweb reports for trade prints where available. Pair those with your vendor's top-of-book and level 2 feeds.

Bottom Line

On-the-run premiums and depth metrics are essential tools for understanding Treasury market functioning and execution risk. They translate dealer constraints and funding stress into measurable numbers you can monitor and act on.

Set up automated alerts on on-the-run/off-the-run spreads, depth, and funding indicators, and use multi-horizon confirmation to distinguish noise from genuine regime change. At the end of the day, measuring liquidity is about mapping uncertainty to actionable execution and portfolio decisions.