Introduction
CME Group is making it easier than ever to trade the price gap between newly issued on-the-run (OTR) government bonds and Treasury futures contracts using Treasury Link.
While the Treasury basis trade between Treasury futures and the cheapest to deliver (CTD) security serves as a crucial link between the cash and futures markets, it is not the only spread trade between cash and futures. OTR Treasuries account for roughly 75% of total cash trading volume, yet they are rarely the CTD security for a futures contract (Figure 1). This creates a distinct market need: trading the spread between Treasury futures and OTR cash, commonly referred to as the headline basis.
Market participants, including primary dealers, proprietary trading firms (PTFs), swap dealers, asset managers and hedge funds, routinely trade this spread to hedge auction inflows and market-making activity, move exposure between futures and cash and capture mispricings.
Treasury Link is the industry’s first platform to seamlessly connect cash and futures liquidity pools. It will enable market participants to electronically trade the spread between Treasury futures and BrokerTec OTR cash Treasuries via a single order with no legging risk and without the need to pay bid-offer spread. While this offering provides an alternative to spreader algorithms and the bilateral exchange for physical (EFP) market, which currently trades an average of $16 billion per day, it also complements these existing market structures.1
Figure 1: Percentage of days where the OTR was cheapest to deliver by tenor, Jan. 2022 through Jun. 2026
Treasury Link brings enhanced spread execution
Currently, market participants execute spreads between cash Treasuries and futures using one of two modalities, such as:
- Spreaders use technology to monitor pricing across venues and generate synthetic spread markets. When an order is submitted through a spreader, it typically places a resting passive order in one market and submits an aggressive order in the other market once the first leg is filled. While spreaders compress latency, they cannot eliminate legging risk. Market participants face a trade-off between legging risk and transaction costs. Avoiding the payment of bid-offer spread requires participants to enter passive orders into both markets, exposing them to legging risk in the time between execution of the two orders. To minimize this risk, traders cross the bid-offer spread in the second leg.
- Exchange for physical (EFP) transactions: While EFPs are privately negotiated transactions that trade as a single package, the over-the-counter (OTC) market structure lacks the speed, transparency and execution efficiency of an electronic CLOB.
Treasury Link resolves these trade-offs by allowing traders to submit a single passive order directly in the spread, eliminating legging risk without requiring them to pay the bid-offer spread. In addition, the ability to electronically trade the spread in a single order unlocks new spread trading opportunities for market participants that will help increase overall liquidity.
Figure 2: Comparing Treasury Link with existing execution modalities
| Treasury Link | Spreaders | Exchange for physical (EFP) | |
|---|---|---|---|
| Electronic CLOB execution | |||
| No legging risk | |||
| Single-order passive fills |
While Treasury Link can offer efficiencies over existing execution modalities, it will also be highly complementary. The CLOB market will offer price transparency to the EFP market and provide market makers with an efficient way to hedge EFP flow, which could improve liquidity in that market. In addition, spreaders can connect to Treasury Link, as they connect to other venues today, to potentially improve execution outcomes.
Servicing a variety of use cases
There are a number of use cases for trading the spread between Treasury futures and OTR cash. Treasury Link provides a new way for market participants to trade this spread electronically without legging risk.
- Banks and primary dealers absorb billions of dollars of new on-the-run issues at Treasury auctions. Shorting Treasury futures allows dealers to hedge the resulting interest rate risk without moving the cash market while they sell down their inventory to clients. Treasury Link enables primary dealers to sell their inventory while simultaneously unwinding their futures hedge. Similarly, dealers hedge their delta from cash Treasury market-making using futures, creating basis exposure on their books that can be hedged using Treasury Link.
- PTFs use futures to hedge directional risk accumulated while making markets in cash Treasuries and execute high-frequency relative value (RV) strategies between venues. Treasury Link enables PTFs to simultaneously unwind cash and futures exposure and unlocks electronic RV trading opportunities.
- Swap dealers often hedge swap trades against clients using Treasury futures and swap spreads. Treasury Link allows swap dealers to cleanly hedge residual spread exposure between futures and cash Treasuries using single-ticket spread execution.
- Asset managers use futures to rapidly equitize cash inflows before transacting an EFP to move risk from futures into specific cash securities. Treasury Link provides an additional mechanism for transferring risk from futures into cash.
- Hedge funds capture mispricings between OTR cash Treasuries and futures contracts alongside basis trade strategies. The ability to execute electronically and receive passive fills provides more RV trading opportunities.
- RV brokers employ sophisticated legging strategies to work orders on behalf of clients. Treasury Link could be integrated to work alongside existing workflows to improve execution outcomes.
Conclusion
A range of market participants trade the spread between Treasury futures and OTR cash Treasuries. By allowing electronic execution in a single order, Treasury Link eliminates legging risk and improves passive execution. This complements what traders can achieve through spreaders and EFP transactions today and ultimately enhances liquidity across these two interconnected markets.
Reference
1 For more information on EFPs, see U.S. Treasury Futures Exchange for Physical (EFP) Transactions.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered legal advice, investment advice or the results of actual market experience. Where regulatory matters are summarized, they represent CME Group’s good faith understanding of the applicable requirements.
