The greatest risk of all is a disorderly bear steepener.

If you’re a longtime reader, you know that’s a refrain that predates the pandemic by several years.

The risk of an unanchored long-end used to center on the implications for mountainous duration embedded across fixed income and also in equities courtesy of massive index weighting for duration-proxy growth shares.

That’s still a risk, and indeed it’s a risk that’s in the process of “realizing,” so speak, but an unmoored long-end predicated on the perception of fiscal ineptitude or, worse, on a witting disregard for fiscal discipline, poses a more existential threat.

Market participants got a glimpse of what it looks like when that existential threat becomes reality in October of 2022. The figure below shows the uncontrolled selloff in gilts that accompanied Liz Truss’s mini-budget boondoggle and the attendant collapse in sterling.

That was a nightmare. That was a developed market sovereign losing control, and experiencing an EM-esque dynamic whereby the currency depreciates in the face of rising yields, indicative of a confidence crisis.

That episode was mostly a testament to incompetence on Truss’s part, but it was also a wakeup call: It can happen in developed markets and, relatedly, it can happen to hard currency issuers.

The question is whether it can happen to the most developed market and the reserve currency issuer. If it does, we’re all screwed. I’m sure there’s a more diplomatic way to put it, but there’s no more apt way to make the point.

Note that the US is nowhere close to that dynamic. There’s no sign of it. The dollar is still inclined to appreciate as US yields (and particularly reals) rise.

That said, BofA’s Michael Hartnett suggested (again) that it could happen in America. “The greatest credit event of all is a disorderly rise in bond yields leading to US dollar debasement,” he wrote, in the latest installment of his popular weekly “Flow Show” series. Such a situation would be “very risk-negative,” Hartnett added.

That’s putting it politely. A situation where the reserve currency depreciates rapidly in the face of an unchecked selloff at the long-end of the sovereign’s yield curve would be harrowing and, as Hartnett was quick to note, it’d “require emergency easing by the Fed.”

By “emergency easing” he didn’t mean rate cuts. You’d need rate hikes in that scenario. Note that the market took to speculating on inter-meeting hikes from the BoE during the Truss debacle. Rather, “emergency easing” in that case would mean QE (recall that the BoE bought bonds on an emergency basis) or even the institution of martial law through yield-curve control.

Is that likely for the US? No. Certainly it isn’t. But, we shouldn’t forget the lesson of the gilt/sterling meltdown. “With the US government running 8% budget deficits in an economy growing >8% in nominal terms and annual interest payments on >$33 trillion of debt now exceeding $1 trillion, it’s little wonder investors are impatient for recession to inspire some de-leveraging,” Hartnett went on. “Until it happens, the risk is investors continue to punish fiscal excess.”