The fate of the universe hangs on the nascent bear steepener in the US curve, along with the concurrent rise in real yields and term premium repricing.

Or at least that’s the way it felt coming out of last week, when a blast of lively price action+ in bonds offered some respite from an otherwise somnolent summer drift.

Naturally, rates vol migrated to the right, particularly over the past two weeks, amid a still resilient macro backdrop in the US, the Fitch downgrade and supply jitters around the refunding. That, in turn, gave long duration equities pause. Or at least for a day.

As Nomura’s Charlie McElligott wrote Monday, the rate vol migration illustrated below is intuitive — it’s indicative of the market’s “plodding and unwilling embrace of ‘higher for longer-er‘ as volatility moves away from the short-term policy tenors and into the belly and long-end of the curve, which has sold off powerfully on the perception of potential structural shifts.”

I assume this is obvious to most readers, but everything that happened last week at the long-end speaks to the largest structural shift of them all — namely the idea that the Great Moderation macro regime died in the 2020s, that r-star is higher now and that market participants and policymakers will have to acquiesce to that reality and adapt going forward.

McElligott spoke to that on Monday, and also mentioned the reappearance of term premium in forwards which he attributed to “a simple truth”: Ballooning deficits means more longer-term borrowing, which is precisely what Treasury tipped last week (there’s more bill supply coming too, of course, but that’s a subplot all its own).

Markets need to internalize an uncomfortable reality in that context. As long as inflation is running well above target, the Fed can’t expand its balance sheet to offset increased coupon supply. Less generously: The Fed can’t perpetuate the Ponzi scheme right now. On the contrary, they’re still letting the balance sheet run down, which is a de facto supply impulse to the extent it puts more of the onus on private investors.

Given that, it’s not surprising to see price discovery make a cameo. That’s what the term premium discussion is about. It’s not a matter of whether there’s demand for US notes and bonds. There’s always demand. The market will clear, but at what price? The smaller the Fed’s footprint, the bigger the role for price discovery.

For McElligott (and he’s not alone), the narrative shift feels too seamless. “The selloff in the long-end may simply be a ‘buyers’ strike’ into peak-of-summer illiquidity in light of so many prior real money buyers of duration on what had been a consensual ‘recessionary outlook,'” he went on. Those buyers are now “way underwater,” Charlie said, suggesting they might’ve just capitulated, “almost like a synthetic form of short gamma / negative convexity.” So, forced selling, but not by investment mandates reacting to Fitch — just plain old selling into lower prices, pushing yields even higher, putting other people further underwater, and so on. (It’s worth noting that hedge funds’ net short in long-end Treasurys was the largest in at least a dozen years as of last week, while asset managers were record long.)

Then there’s “a feel concern” related to the rapidity of what Charlie aptly described as a “consensus surge into the ‘no recession’ / ‘soft landing’ frenzy” which he said might be a bit “too tidy” at this point. After all, he noted, the US is seeing “ongoing declines in hours worked,” not to mention six straight months of negative NFP revisions, the longest such streak since the second half of 2007.