U.S. equity funding markets are still under strain following a sharp rise in short-term borrowing costs last month, as stock prices hover near record levels and intense demand for leveraged technology trades keeps the pressure on.
The concern is focused on the equity repurchase — or repo — market, where investors borrow short-term cash using their stock holdings as collateral. As the June quarter came to a close, the cost of that borrowing surged dramatically. According to data from Morgan Stanley, financing costs for equity positions climbed to roughly 200 basis points above the federal funds rate on June 26 — the highest level since December 2024.
Those costs have since dropped by more than half, now sitting around 89 basis points based on a metric with a quarterly maturity. But market insiders say the underlying conditions that pushed rates so high are still very much present — including a boom in leveraged exchange-traded funds that traders have been snapping up to bet on high-demand sectors like semiconductors.
That sustained appetite for leverage means another round of funding stress could be coming, particularly around future quarter-end periods, when banks typically pull back from lending to clean up their balance sheets for reporting purposes. That pullback makes short-term cash harder to get and more expensive, which can trigger a broader retreat from popular market positions.
“The risk of a funding spike may be with us for the foreseeable future,” said Martin Tobias, a U.S. rates strategist at Morgan Stanley in New York.
Multiple indicators suggest investors are leaning on borrowed money more than ever, Tobias said. Under normal circumstances, equity financing rates trade only a few basis points above benchmark rates like the federal funds rate or the Secured Overnight Financing Rate, known as SOFR. Because equity financing is backed by highly liquid collateral — unlike unsecured borrowing — the cost should stay only slightly above the risk-free rate, according to Kevin Muir, an independent proprietary trader based in Toronto.
Despite that collateral advantage, financing costs have stayed elevated. That coincides with primary dealers carrying near-record levels of equity financing exposure on their books, with borrowing heavily concentrated in a narrow group of stocks — mainly technology and semiconductor companies. Federal Reserve figures show dealers held approximately $211 billion in such exposure as of June 24.
“What these equity financing metrics are signaling is that the marginal buyer has become one that’s been increasingly reliant on leverage,” Tobias said, referring to the category of market participants — such as leveraged investors — who actually move prices.
Tobias noted that his measure of dealers’ equity repo exposure relative to the S&P 500’s free float adjusted market capitalization has climbed 50% over the past year, a sign that each dollar of investible equity is increasingly propped up by borrowed money.
The market’s leadership has also narrowed, with leverage appearing to concentrate in hot technology sectors. That makes the broader market more susceptible to a sharp reversal if investor sentiment turns.
“The next correction could very well be much larger than people expect because of the crazy amount of speculation that’s occurring,” said Muir, adding that the recent funding spike “signifies the monstrous amount of demand in equity markets.”
Muir pointed to the rapid expansion of leveraged exchange-traded funds as one key example. These products require banks and dealers to take on additional financing and hedging, leaving the market heavily positioned for just one outcome — rising stock prices. He compared the current climate to a crowded trade where optimism has become deeply embedded, warning that while a correction isn’t necessarily around the corner, any eventual pullback could be significantly more severe as a result.
Sam Earl, a U.S. rates strategist at Barclays, frames the situation as a basic supply-and-demand problem. Demand for equity financing has surged, but dealer balance sheet capacity has not kept up.
“When you have a massive run-up in equity prices so quickly, that’s just a ton of balance-sheet capacity that’s being used,” Earl said.
He estimates the equity financing market is approximately $10 trillion in size. A 10% increase in leveraged equity exposure can generate roughly $1 trillion in additional financing demand. Add in strong gains in overseas markets — particularly in Asia — and available capacity can be consumed quickly.
Earl said similar pressures are likely to return unless dealer balance sheets expand considerably or stock prices cool enough to ease financing demand. Neither of those outcomes looks likely anytime soon. U.S. stocks remain near record highs, though brief pullbacks tied to geopolitical developments — such as headlines around Iran — remain possible. Enthusiasm for technology and artificial intelligence trades continues to run strong, and demand for leverage shows little sign of letting up.
“It’s a very dangerous environment if this all unwinds. The potential for an accident is increasing,” Muir warned.
