Global equity markets are pushing to record highs on artificial intelligence optimism, but the rally is increasingly fueled by debt, raising concerns about how stable it really is. U.S. margin debt climbed to a record $1.42 trillion in May, up more than 50% from a year earlier. At the same time, leveraged ETFs have nearly doubled in value within just over two months, reaching roughly $220 billion.
Leverage builds beneath record highs
The rapid expansion of borrowing is drawing scrutiny as signs of strain begin to emerge. Barclays estimates that leveraged funds have accumulated around $300 billion in equity derivatives since late March, a buildup that could intensify market swings if positions are unwound quickly.
Morgan Stanley points to early warning signals in funding markets. The AXW futures spread, which measures the cost of stock financing relative to overnight rates, has climbed to its highest level since December 2020, suggesting tighter credit conditions for traders.
Concentration in technology amplifies risk
The surge in leverage is heavily concentrated in technology and semiconductor trades. Leveraged ETFs linked to these sectors account for most of the recent growth, with assets tied to semiconductor indexes jumping from about $115 billion at the end of March to $220 billion by early June.
This concentration is contributing to increasingly uneven market performance. Information technology has been the dominant driver of gains, while most other sectors have lagged. Over the past year, the majority of trading sessions have seen fewer than half of sectors outperform the broader market, highlighting the narrow base of the rally.
Feedback loops heighten volatility
The structure of leveraged ETFs can amplify both gains and losses. These funds rebalance by buying into rising markets and selling into falling ones, creating self-reinforcing cycles. During downturns, falling asset values can trigger additional selling, accelerating declines and increasing volatility.
South Korea offers a warning sign
Recent turbulence in South Korea underscores these risks. The KOSPI index, after a sharp rally this year, triggered circuit breakers twice in one week amid steep declines. Leveraged exposure in the market has reached up to five times underlying positions, with total leverage estimated at 271 trillion won.
A drop of between 16% and 36% in underlying assets could force margin calls. Trading in leveraged products tied to major tech names like Samsung Electronics and SK Hynix has at times accounted for up to half of their daily volume, reflecting the scale of speculative activity.
Regulators say many participants in these trades are retail traders, adding to concerns about market fragility during periods of heightened volatility.
Funding pressures begin to surface
In the United States, leverage is also building through institutional channels. Federal Reserve data shows primary dealers’ equity exposure via repo financing has reached a record $223 billion. Morgan Stanley’s measure of equity financing dependence has surged nearly 50% over the past year.
Meanwhile, broader financial conditions have quietly tightened. Higher Treasury yields and a stronger dollar have effectively added the equivalent of a 31-basis-point rate increase since mid-April. Gains in equities have masked some of that impact, but analysts warn that any deleveraging could quickly expose the underlying pressure.
Outlook tied to rate path and leverage unwind
Morgan Stanley expects the Federal Reserve’s policy rate to settle around 3.00% to 3.25% by mid-2027, assuming gradual rate cuts next year. However, a sharp market correction driven by forced deleveraging could disrupt that outlook as tightening financial conditions feed back into asset prices.
Barclays strategist Altmann noted that the tailwind created by rapid leverage expansion may soon reverse. If that happens, the same dynamics that powered the rally could magnify losses, leaving markets vulnerable just as dependence on borrowed money peaks.
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