U.S. stock market margin financing has reached a historic limit! Morgan Stanley warns: a deleveraging storm is brewing.
When the US stock market is pushed to the limit by buying stocks on borrowed money, the cost of a reversal will be amplified by the same leverage.
According to Chase Wind Trading Desk, On June 15, Morgan Stanley’s US Rates Strategy team published a report stating that marginal buyers in US stocks are increasingly dependent on leveraged financing, which is becoming more expensive and scarcer. Leverage buyers are struggling to sustain their positions.
This phenomenon is like the “canary in the coal mine”—an old practice where miners used canaries to detect poisonous gases, implying a kind of early warning signal is appearing.
Financing costs soar to historic extremes: Margin trading is increasingly expensive
The core indicator for measuring stock financing costs is AXW futures—it tracks the spread between the implied financing rate of S&P 500 total return futures and the benchmark rate (SOFR).
Data shows the 1-month AXW futures contract expiring June 2026 briefly surged to +140 basis points last week. Even after the S&P 500 retreated from its historic high, this indicator remained at extremely high levels. Calculations show this is the highest level since December 2020 (excluding special year-end periods).
What does this mean? Simply put: The cost for leveraged investors like hedge funds to borrow money to buy stocks is now historically rare and expensive.
Why are financing costs so high? Essentially, it’s an imbalance of supply and demand:
- Demand for leveraged long stock positions is continuously inflating;
- But dealers’ balance sheet capacity is limited—subject to GSIB (Global Systemically Important Bank) capital requirements, regulatory capital, and internal risk budgets.
High demand and tight supply naturally push up financing costs. Once financing costs reach a critical level, leveraged investors can no longer add to positions, and may even be forced to reduce them.
$223 billion: Primary dealers' stock repo exposure hits historic highs
Besides financing costs, another more direct figure comes from the weekly primary dealer data released by the New York Fed.
As of the week ended June 3, 2026, the US primary dealers’ equity exposure through repo and other securities financing reached $223 billion, a historic high.
Some might ask: Stock prices are up, so financing scale naturally increases—isn’t this normal?
Morgan Stanley broke this down specifically. They constructed a "stock financing dependence" indicator: dividing the primary dealers' stock repo scale by the S&P 500 free float market cap.
If the growth in financing scale only passively follows the rise in stock prices, this ratio should be roughly stable.
But the result is: This ratio has surged nearly 50% in the past year, nearing the historic peak from mid-March 2026.
This means that behind every dollar of market value, more and more borrowed money is accumulating. Leverage buyers have become the market's marginal price setter.
More notably, this financing demand is highly concentrated in a few sectors such as semiconductors.
All money piled into one sector: Semiconductors
Leverage being concentrated in a handful of sectors directly leads to extremely narrow market breadth.
The firm's sector breadth diffusion index shows: In the past three months, among 11 GICS sectors, only one sector outperformed the S&P 500—Information Technology.
And within Information Technology, the sub-sector making up about 50% of its weight is semiconductors and semiconductor equipment.
From specific data, Information Technology rose 24.2% over the past three months, with an excess return of 13.3% versus the S&P 500. Other major sectors—be it consumer, finance, healthcare, or energy—had negative excess returns compared to the S&P 500 over the past three months. Over the past year, on about 70% of trading days, no more than five sectors beat the S&P 500.
This extremely concentrated market structure means the overall market rise is actually being propped up by leveraged funds in a handful of stocks and sectors. Once these funds begin to retreat, their impact on the wider market will be amplified.
Rises are driven by leverage; falls are driven by leverage—in the opposite direction
Morgan Stanley laid out a clear logic chain:
High financing costs → Leverage buyers unable to add positions → Marginal buyers disappear → Market loses upward momentum → Price correction → Deleveraging triggered → Selling pressure amplified by leverage → Drop exceeds expectations.
In the analyst’s own words: "The technical force that previously amplified upward momentum through leverage expansion may start to cut in the opposite direction."
Historical data confirms this logic: AXW futures’ periodic highs often coincide closely with the S&P 500's periodic tops.
Financial conditions have quietly tightened, but most investors are unaware
The report’s Financial Conditions Index (FCI) integrates five variables: 10-year US Treasury yield, S&P 500 returns, BBB credit spreads, US dollar valuation, and oil prices, converting them into equivalent changes in the federal funds rate.
Data shows: Since the Iran conflict erupted until June 11, financial conditions have tightened by the equivalent of a 31 basis point increase in the federal funds rate, mainly driven by rising 10-year US Treasury yields and dollar appreciation.
However, since the stock indices remain rising, most investors haven’t felt this tightening. In fact, since the Iran conflict, the S&P 500's rise has contributed about -21 basis points of loosening effect to financial conditions (as of June 11), partly masking tightening from other factors.
But in the correction after the S&P 500’s record high on June 2, the stock market has contributed +12 basis points of tightening to financial conditions.
This is the crux of the issue: When the stock market driven by leverage makes investors mistakenly believe financial conditions are “loose,” once deleveraging triggers a market fall, investors will be forced to reassess financial conditions, and thus reprice the Fed's policy path.
Once deleveraging starts, expectations for Fed rate hikes will collapse first
The firm’s base case is: inflation will keep falling until 2027, the Fed will cut rates by 25 basis points each in March and June 2027, with the final target policy rate range at 3.00%-3.25%. Before the June FOMC meeting, the Fed officials’ median forecast is expected to show no rate change in 2026 and a total 50 basis point cut by 2028.
Against this backdrop, if the market drops further and leveraged investors are forced to deleverage, investors' views on financial conditions will fundamentally change—they will realize conditions aren’t as "loose" as imagined, and reduce their weighting in pricing the tail risk of Fed rate hikes.
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The above excellent content comes from Chase Wind Trading Desk.
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