A month or so ago, I wrote a bit about an under-the-radar funding squeeze for equity financing.

The simple version — i.e., leaving out superfluous jargon and stripping the issue down to the basics  — goes like this. Equities upside, and specifically US equities upside, is in high demand, which is to say investors want more exposure. That exposure has be financed, and dealer balance sheets are finite. When insatiable demand meets finite supply, the cost of whatever it is — in this case funding for long equity exposure — goes up. As noted on November 19, this isn’t especially complicated at the conceptual level.

As long as equities continue to melt-up, and absent meaningful regulatory relief for the institutions involved in financing synthetic stock longs, the cost of that exposure should be expected to rise. I don’t have anything “new” to say about this dynamic per se, but while perusing a few notes on Monday evening I came across some sparse color and a few charts on the subject that are worth highlighting.

The figure on the left, below, from SocGen’s Jitesh Kumar, gives you a sense of the trajectory and the relationship between the cost funding and equity performance.

“The cost of financing a long synthetic position in the S&P index has climbed to 100bps above benchmark rates,” Kumar wrote, adding that “bank balance sheets are under pressure from financial asset supply/demand imbalances, as well as seasonal regulatory pressures.”

He also flagged the growth in leveraged ETF AUM as a contributing factor.

The figure on the left, below, suggests equity repo activity doubled in 2024, putting significant strain on balance sheets which are struggling to cope with such a sustained rise in demand.

The figure on the right is just another visualization of the ballooning leveraged ETF universe.

At the end of the day, it all comes back to the same simple principle(s). Here’s Kumar:

The cost of funding synthetic (i.e. leveraged) exposure to large-cap equities has risen to all-time highs, exemplified by the US, [and] while regulation[s] on balance sheet usage… continue to impose constraints to this day, most of this rise in funding cost can be explained by the imbalance between this limited supply and growing demand rising from the spectacular rise in equities over the past two years.

Or, as I put it a month ago, “If you want to explain the price of something, a good place to start is supply and demand.”