Title: When Fast Markets & Tighter Funding Collide — Forest for the Trees Show: Paulo Macro (Substack) — paid Guest: Paulo Macro ("Cloudbear") Date: 2025-NOV-25 URL: https://paulomacro.substack.com/p/when-fast-markets-and-tighter-funding Length: written post (no timestamps) Note: Back-filled post (processed 2026-JUL-07; predates most of the source's archived posts). A quick note: as risk relief-rallies into Thanksgiving, the "invisible" forest is FUNDING. Walks equity-funding mechanics (the AIR TRF / AXW proxy) and argues the tightening driver is quietly handing off from leverage demand to dealer balance-sheet supply. Macro-heavy; only MSTR named as a security (illustrative). Body reproduced for personal study; Substack chrome removed.
A quicker note today as the market signs a breath of relief into the Thanksgiving holiday.
In this weekend's note out yesterday morning, I wrote: "The narrative around NVDA, OpenAI, and data centers is in serious trouble. I appreciate the temptation to conclude that all the negative press over the past 72 hours around NVDA's share price and the Google Gemini GPU terminator might suggest contra trades, but I think people are losing sight of the forest for the trees. Just because bubble decriers have spent two years being run over by a bubble doesn't mean there won't be blood when the turn comes, and in narrative space, the turn is real. Once you are on the backside of the narrative and flow mountain, it is a long way down in time and price. Trade the wiggles if you must, but stay focused on what matters. Still, we all know there will be furious short-covering relief rallies along the way, and the challenge as mentioned at the top is what if we get one as a function of last week's selling?"
There is a bigger issue with the forest is a key element that is suddenly, oddly invisible as people look to the Fed for salvation on December 10th (hawkish rate cut? I have no strong views here).
That issue is funding. Admittedly there has been some talk by commentators recently around tightening liquidity, with analysts like Michael Howell of Capital Wars giving several appearances (he's done some good work laying out the challenges faced). Specifically, the situation around funding as it plays into tightened liquidity and a collateral-liquidity feedback loop remains a problem, and the relief rally since Friday morning is running headlong into something that the Fed will absolutely need to address in December — particularly given the funding needs around year end. As we jam higher in risk and FOMO leaks back in for a year-end chase, I have a few pointers to keep in mind:
First, the Fed's Standing Repo Facility (SRF) is back to seeing a sizeable draw today, and the collateral pledged here is not pledgeable back-to-back (so it's not "leverageable" collateral in the context of the system) — it's a cash injection for a specific player or players who have no other options at cheap market rates.
Short-term rates have remained persistently within the upper half of the Fed's corridor as we have cited before, and this morning repo general collateral rates blew through again.
This tightened USD liquidity is showing up in the FX basis swaps market as well… see USD/JPY 3m TONA vs SOFR.
Tightening liquidity is also starting to creep into equities now as well — subtly so far as I will explain — specifically in funding for leverage.
My friend Kevin Muir of The Macro Tourist wrote a great primer on equity funding back in early September which I would recommend people read if they are curious. A little bit of background from Kevin:
"Banks charge their customers (pensions, hedge funds, endowments) different rates to borrow in financial markets. The level is not based solely on the client's credit worthiness, but also the asset pledged as collateral. U.S. 3-month T-bills get funded at a much lower rate than MSTR convertible bonds. There is a general rate for equity funding that many sell-side shops report to their clients on a daily basis. This rate garnered all sorts of concern. As demand for equity funding rose, the cost of that funding increased.
Let's take a simple example where a pension fund wants to gain exposure for the next year to the S&P 500. Maybe they have made private loan commitments, but don't know the timing of the required funds, so they want to buy the S&P 500 by borrowing from the bank (keeping the funds available for the 'capital call' in the other asset class).
The pension fund enters a swap agreement where they receive the total return of the S&P 500 and they pay out what is usually a floating rate that resets at regular intervals (this might be based on the SOFR or Effective Fed Funds rate). The pension fund and the bank exchange cash flows throughout the life of the swap based on the agreement. Since the bank needs to borrow those funds to pay for the stocks held on their balance sheet, there is a cost to facilitate the trade. They are in essence saying to the pension fund, we will buy the S&P 500, hold it for you, and charge a fee for this service (don't forget the bank has no market risk, if the S&P 500 goes up, they owe that return to the pension fund, and if it declines, the pension fund will make them whole).
That fee ends up being the 'cost of funding equity positions.' As more clients ask for this sort of exposure, it makes sense that the issuing banks would charge more. After all, even though the risk is low, the bank still has increased equity concentration risk (in the event the pension fund can't pay). For the last quarter of 2024, the cost of this funding more than tripled."
Important to keep in mind: funding tightness can be a function of players reaching for leverage in being very long equities (rising demand for funding), or tightening balance sheets at dealers (declining supply for funding). It's not always clear which is driving the bus, so most would dismiss this from a trading timing perspective. I'll come back to this.
Because there is a product for everything, the CME now has an Adjusted Interest Rate (AIR) Total Return future on US equity indices (this listed proxy for equity funding can be found on Bloomberg under the ticker AXW). An AIR TRF is basically a listed total return swap quoted as a rate over either EFF (effective Fed Funds) or SOFR (secured overnight financing rate). Here's Kevin again:
"But wait, how does that differ from an index future? Well, the index future is simply a forward. To properly price an index future, a trader needs to estimate the expected dividends and then discount it by the expected cost of funding that position. There is an embedded dividend assumption and interest rate in the forward price. The AIR TRF removes all the risks from dividends and interest rates, leaving the price as simply the cost of funding an index equity position."
With the mechanics explained, let's take a look at this proxy for equity funding over the past two years.
The first thing that stands out is the funding tightness in 4Q last year which reflected the wild growth in demand for leverage (including the oft-touted 2x or 3x levered funds on single stocks and equity ETFs) that was soaring post-election as we approached year end. This was clearly demand-driven tightness that was relieved following Dec 31st, and then bled lower as speculative demand cooled into and after the Liberation Day collapse. Putting the growth in levered ETF AUM in context, you can see the rinse once the market went Risk Off in March.
To repeat: we need to remember that funding tightness can be a function of levered players getting very long equities (rising demand), or tightening balance sheets at dealers (declining supply), and it's not always obvious whether the demand of a leveraged speculative mania or a balance sheet funding crunch is the key driver of equity funding.
It is tempting to think with the AIR TRF chart above that there is no issue in equity funding at the moment, but there is something brewing here. Note how equity funding has generally priced in a range of 40-80bps over EFFR or SOFR (horizontal green lines). What I see is that funding has been creeping higher (tighter) since late summer, but importantly despite the release of some leveraged players and retail blasting in Meme stocks and leveraged ETFs — has not eased notably and is still trading in the upper end of the band.
This isn't a crisis for now, but in my opinion it's a sign that the demand for funding as the primary tightening driver into the October top is handing the baton to supply constraint by way of gradually tightening dealer balance sheets. We'll want to keep an eye on this, as funding and liquidity tightness is starting to reflect in not just FX basis swaps and other rate markets on the margin, but also because equities are continuing to diverge relative to junkier credits going all the way back to September (and in CCC land, January!).
With this general liquidity suck as context, is it any wonder that Bitcoin's bounce is "weak sauce"?
All I'm saying is… stay frosty.
Kind regards,
Paulo aka Cloudbear