Equity funding costs hit 2008 levels as leverage overloads markets

Equity financing costs have surged to levels last seen during the global financial crisis, signaling that leveraged bullish positioning has reached dangerous extremes.

The cost of funding long S&P 500 positions has surged to 183 basis points, matching levels last seen during the 2008 global financial crisis. The spread on total return swaps for July 31 expiry on the benchmark index closed at that level, according to JPMorgan's derivative strategy team led by Bram Kaplan.

"It's screaming danger and no one is listening," said Kevin Muir, author of The MacroTourist newsletter and a former derivatives trader at RBC Capital Markets and Wintor Capital. Muir said the jump in spreads is explained by banks "who collectively understand the risks are demanding higher rates to facilitate borrowing against equities."

Spreads across the maturity curve sit in the 95th percentile of the last five years — a level typically seen only at year-end when banks rein in balance sheets. Levered exchange-traded fund exposure has ballooned to roughly $500 billion from $200 billion two years ago, according to Goldman Sachs data. The tightness in funding reflects explosive demand for leveraged exposure, not a contraction of supply from the banks, Muir said.

The funding stress signals a market stretched too far to the upside from speculation, Muir warned, describing it as "a boat that is far too loaded with long positions." A sudden deleveraging event could trigger widespread liquidations, amplifying downside volatility across major equity indices.

Cross-Asset Stress Builds

The equity financing squeeze comes as stress is building across other corners of the market. The U.S. 10-year Treasury yield held near 4.51% on Thursday, while the VIX — Wall Street's fear gauge — sat at 16.52, down 0.42% but still elevated relative to the complacent levels seen earlier this year. The DXY dollar index remained firm, adding pressure on risk assets.

Hedge funds are positioning for dislocation. Lee Robinson's Altana Wealth is building bearish wagers against U.S. life insurers through credit default swaps, running a playbook he compares to his subprime mortgage short during the 2008 crisis. Altana's Credit Opportunities fund is up 47.5% year to date and 416% since inception in 2020. Hedge funds have more than doubled short positions against U.S. life insurance stocks over the past year, with net notional bets on insurers' CDS rising to $5.5 billion by late May, according to DTCC data.

The convergence of record equity financing costs, surging levered ETF exposure, and rising hedge fund bearishness across credit markets paints a picture of a market where the easy money has been made. The next catalyst — whether a data miss, a geopolitical shock, or a single blow-up in a levered position — could trigger the unwind that funding markets are already pricing in.

This article is for informational purposes only and does not constitute investment advice.