What is the On-The-Run Treasury Yield Curve?
Let me explain this directly: the on-the-run Treasury yield curve is a graphical representation that shows the current yields versus maturities of the most recently issued U.S. Treasury securities. You should know it's the primary benchmark for pricing fixed-income securities.
Key Takeaways
As I see it, the core point is that this curve plots yields against maturities for the newest Treasuries and stands as the main reference for fixed-income valuation. It's the opposite of the off-the-run Treasury yield curve, which deals with older U.S. Treasuries of the same maturity that aren't from the latest issue. Keep in mind, the on-the-run version is less accurate than the off-the-run one because fluctuations in demand for new supply often cause price distortions.
Understanding the On-The-Run Treasury Yield Curve
To put it simply, I'm talking about the U.S. Treasury yield curve built from on-the-run Treasuries, where you plot the yields of these similar-quality instruments against their maturities. This contrasts with the off-the-run curve, which covers Treasuries of a given maturity that aren't the most recent. You need to recognize that the on-the-run curve is less precise due to demand volatility distorting prices.
Its importance comes from being a common tool for pricing fixed-income securities, but the shape can get distorted by several basis points if an on-the-run Treasury goes 'on special.' That happens when its price gets temporarily pushed up, often because securities dealers demand it for hedging. This makes the on-the-run curve somewhat less reliable than the off-the-run one.
The Treasury yield curve highlights two key factors complicating the maturity-yield relationship. First, yields on on-the-run issues get distorted since they can be financed cheaper, leading to lower yields than without that advantage. Second, on-the-run and off-the-run issues carry different interest rate reinvestment risks.
Yield Curve Shapes
The usual shape for the on-the-run Treasury yield curve slopes upward, with yields rising as maturity increases—this is what we call a normal yield curve. You can attribute the curve's shape to supply and demand in specific segments.
For instance, if an investment fund focuses only on 5- to 10-year maturities, that boosts prices and drops yields in that area. Extremely high demand from short-term investors will steepen the curve.
An inverted yield curve shows higher rates for shorter maturities than longer ones, sometimes caused by aggressive central bank policies that temporarily hike short-term rates to cool the economy. This inversion is viewed as a short-term issue, with expectations it will flatten or turn positive soon.
A flat yield curve, where short- and long-term rates are roughly equal, typically signals a transition period as rates shift from a positive to inverted curve or the reverse.
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