History Rhyming

We are seeing the financial merry go ground slowing down.

First, we have banks starting to call in loans from hedge funds as a result of concerns about the possible collapse of the AI bubble.

Wall Street banks have demanded more collateral from hedge funds in recent weeks as a rout in AI stocks accelerates and triggers heavy losses across several popular strategies.

Banks asked funds whose holdings are heavily concentrated in certain industries to provide additional collateral to keep their existing levels of leverage, according to four people familiar with the matter.

The collateral demands highlight the mounting fears on Wall Street about the scale and speed of the sell-off in AI stocks over the past fortnight, which has upended a rally in a sector favoured by many funds.

……… 

Banks build in protections when lending to hedge funds to make sure they do not incur losses in case the market turns negative. 

Meanwhile, on a slightly more personal scale, we are seeing a spike in the level of margin debt on the New York Stock Exchange.

When people start buying stocks with borrowed money at rates not seen since the dot-com bubble, someone usually gets hurt. Deutsche Bank is now waving the yellow flag.

The bank’s credit strategists, led by Steve Caprio, published a warning on July 24 that US margin debt has crossed the $1 trillion mark as of June 2025. That’s not just a round number for headlines. As a share of GDP, margin debt has now surpassed levels seen during the late-1990s tech mania and is closing in on the 2021 all-time high. 

The numbers behind the warning

Here’s what caught Deutsche Bank’s attention: NYSE margin debt jumped 18.5% from April to June 2025. That two-month sprint ranks as the fifth-fastest increase since 1998, a period that includes some of the most memorable market blowups in modern history.

Finally, and I'm going to quote the hed, "The bond market hasn’t been this calm since the dot-com bust and the financial crisis. History warns of a rude awakening." 

The spreads between high and low quality debt is shrinking, which tends to happen before a crash.

For all the current economic and geopolitical turmoil, the U.S. bond market is remarkably sanguine about the risks of a U.S. economic recession, even after oil’s big price jump.

To appreciate the bond market’s seemingly unconcerned behavior, consider the high-yield bond spread, which represents the additional compensation bond investors demand for incurring the extra risk that high-yield (“junk”) bonds represent relative to U.S. Treasurys.

The junk spread rises along with the risk of recession, when issuers of high-yield bonds become less likely to be able to repay, and it falls when the risk of an economic downturn is lower.

At the end of June, when a barrel of Brent crude was selling for $73, the junk spread stood at 2.75 percentage points. Currently, with Brent crude near $100 per barrel, the spread stands at 2.68 points. While a 7-basis-point decline is not in itself particularly meaningful, it is highly significant in light of the increased likelihood of economic distress to which the higher oil price leads.

In addition, we shouldn’t forget that oil’s recent spike comes on top of a private-credit market that has already been struggling. In its recent report on the state of private markets in 2026, MSCI writes that this market is facing problems even deeper than previously known: “Among loans in private-credit funds, 15.7% have been marked below 80% of principal — a rough threshold for distress — and more than 10% are now marked below 50% — a level typically associated with deep distress or risk of restructuring.”

MSCI’s report reflected the state of private markets at the end of 2025’s third quarter, the latest period for which data were available. Since then, conditions in the private-credit market have deteriorated even more, but the junk spread has narrowed rather than widened — to 2.68 percentage points from 2.80. 

Moreover, as you can see from the chart above, the junk spread is now lower than at any time since immediately prior to the 2008 global financial crisis. The only other time since 1997 that the spread was lower than today came near the top of the dot-com bubble. We don’t need to be reminded what happened after that. 

We are in for interesting times.