Deleveraging Watch
Doug Nolan
As they say, markets are all about greed and fear.
There’s a natural ebb and flow, as participants travel the winding road of progressive risk embracement, tested by occasional bouts of risk aversion.
The force of marketplace whims is deeply influenced by the various stages of the speculative cycle.
Derivatives and speculative leverage hugely impact contemporary market behavior.
This is especially the case in the current late-cycle dynamic, speculative impulses crystallized from successful resolutions to a series of “risk off” episodes.
Today’s late-cycle dynamics are especially affected by the perception of the all-powerful Federal Reserve liquidity backstop, coupled with an administration that will uniquely do and say anything to sustain the bull market (through the midterms and beyond).
Markets suffered a significant “risk off” period in 2022, with deleveraging dynamics gaining momentum around the Autumn UK gilts crisis.
While cut short by the Fed/GSE’s quick $500 billion liquidity injection, “risk off” was taking hold during the March 2023 Silicon Valley bank/bank run crisis.
Japanese yen “carry trade” unwind was on the brink of triggering a more systemic deleveraging in July 2024.
That September, the Fed surprised the markets with the first of three straight rate cuts.
Then with April 2025 “liberation day” instability, deleveraging was at the cusp of turning highly problematic.
The President’s tariff “pause” triggered a major short squeeze and reversal of market hedges.
The resulting “blow-off” liquidity onslaught and loosened conditions were exacerbated by three additional consecutive rates cuts beginning last September.
It’s worth noting that money market fund assets have surged $916 billion, or 18% annualized, since the week of April 16th.
I associate this monetary inflation with the rapid expansion of already huge, levered Treasury holdings financed in the “repo” market (i.e., “basis trades”).
This massive liquidity dislocation stoked manic speculative excess in equities, corporate Credit and crypto, while feeding the historic AI mania and arms race.
Importantly, this liquidity and speculative melee masked festering late-cycle issues, at home and abroad.
Despite a formidable confluence of liquidity overabundance, loose credit conditions, and booming markets, cracks nonetheless surfaced in U.S. high yield finance.
The implosions at First Brands and Tricolor revealed serious deficiencies in lending standards, risk intermediation, structured finance, debt ratings, and such.
Leveraged loan prices came under significant pressure, while booming “private Credit” was viewed with a more jaundiced eye.
There were clear parallels to the 2007 subprime mortgage implosion, which proved a momentous Credit cycle turning point – presaging the 2008 crisis by 15 months.
Bitcoin dropped 7.1% last Saturday, fell another 2.3% Sunday, rallied 2.7% Monday, dropped 3.0% Tuesday, was clobbered 4.6% Wednesday, sank 13.1% Thursday, and then rallied 11.5% on Friday.
Six sessions of historic Silver market volatility – down 26.4%, down 7.0%, up 7.4%, up 3.5%, down 19.6%, and up 9.8%.
The Goldman Sachs Most Short Index gained 1.5% Tuesday, dropped 3.4% Wednesday, sank 6.7% Thursday, and rallied 8.8% on Friday.
The Dow Transports surged 8.7% this week, while the Bloomberg Software Index sank 6.9%.
The Banks jumped 5.1%, and the Mid-caps rose 4.4%, while the MAG7 Index slumped 4.7%.
Money market fund assets surged $85 billion last week to a record $7.797 TN.
Dow 50,000.
In short, Unbelievable Monetary Disorder.
Notably underperforming, the MAG7 Index fell 1.5% Tuesday, lost 1.7% Wednesday, dropped 1.8% Thursday, and then recovered only 0.4% in Friday trading.
Losses for the week included Amazon 12.1%, Meta 7.7%, Microsoft 6.8%, Tesla 4.5%, Alphabet 4.5%, and Nvidia 3.0%.
Nvidia dropped 2.9% Monday, fell 2.8% Tuesday, dropped 3.4% Wednesday, and declined 1.3% Thursday – sinking 10% in four sessions, the most intense selling pressure since April.
The stock then surged 7.9% Friday.
Oracle was down 2.7%, 3.4%, 5.1%, 7.0% - for a four-day 17.1% pounding (exceeding even April losses).
The stock recovered 4.6% in Friday’s session.
Amazon dropped 13.4% in four sessions (Tues-Friday).
The Semiconductor Index gained marginally (0.6%) this week, though volatility was anything but marginal.
The SOX gained 1.7% Monday, fell 2.1% Tuesday, sank 4.4% Wednesday, and was little changed Thursday before rallying 5.7% Friday.
The Bloomberg Software Index declined 1.1% Monday, was slammed 6.9% Tuesday, recovered 1.1% Wednesday, fell 2.1% Thursday, and rallied 2.1% on Friday.
Losses for the week included Intuit 11.1%, Salesforce 9.9%, Synopsys 8.2%, Block 7.4% and Workday 7.2%.
February 5 – Reuters (Jeffrey Dastin):
“Technology startup Anthropic… launched what it called an improved artificial intelligence model, days after its product advances helped kick-start a selloff of traditional software stocks.
The… lab, which is backed by Amazon.com and Alphabet's Google, said its Claude Opus 4.6 model is an upgrade to the Opus 4.5 model released in November.
The new AI can work on tasks for longer and more reliably, while showing gains related to coding and finance, Anthropic said.”
“Anthropic Releases AI Upgrade as Market Punishes Software Stocks.”
“Dan Ives Says Software Selloff is Worst He’s Seen in 25 Years…”
“Global Software Stocks Extend Losses Amid Fears Over AI-led Disruption.”
“The Dark Side of A.I. Weighs on Tech Stocks.”
Only during a manic silly season would a historic $3 TN AI arms race not conjure disruption dread.
It appears the AI honeymoon has run its course, with software only the most obvious risk.
“Software Rout Hurts Debt of Companies.”
“How the Software Panic Hit BDC Stocks.”
“Private Credit Stocks Keep Falling as Software Wipeout Spreads.”
“Heard on the Street: A Bad Time for Private Credit’s Trust-Me Numbers.”
“Private Credit Stocks Keep Falling as Software Wipeout Spreads.”
Apollo Management declined 1% on Monday, sank 4.8% on Tuesday, rallied 4.7% on Wednesday, sank 5.1% on Thursday, and recovered 5.5% on Friday.
Blue Owl dropped 1.6%, sank 9.8%, slipped 0.4%, slumped 3.6%, and rallied 7.7%.
Similar volatility dogged KKR, Ares Management, and Blackstone.
Blackstone sank 8.9% this week, expanding y-t-d losses to 15.9%.
KKR slumped 9.7% (down 19.0% y-t-d), with Areas Management slammed 12.8% (down 19.3%) and Blue Owl hammered 8.2% (down 16.2%).
And remember that these “private Credit/capital” stocks are coming off a rough fourth quarter (First Brands, Tricolor, leveraged lending, etc.)
February 3 – Bloomberg (Olivia Fishlow and Laura Benitez):
“Some call it the ‘SaaSpocalypse.’
Others are saying it’s a software ‘loan-ageddon.’
Whatever the name, shares of Wall Street’s largest alternative-investment firms plunged on Tuesday, driven by fears that artificial intelligence-driven disruptions would cause steep losses on their books.
Blue Owl Capital Inc., which initially focused on financing software businesses, led the decline, tumbling as much as 13% before closing at the lowest level since September 2023.
Ares Management Corp., KKR & Co. and TPG Inc. each fell by more than 10% at one point, while Apollo Global Management Inc. and Blackstone Inc. dropped by as much as 8%.
The decline in alternative investment firms’ shares caps a bruising start to the year.
Last month marked their worst January in a decade, and the largest of them are down roughly 15% since the start of the year.”
February 4 – Bloomberg (Shannon D. Harrington):
“As the AI-induced market selloff in software companies persisted on Wednesday, distressed mounted in the leveraged loan market, where private equity firms funded a host of buyouts in the sector in recent years.
The amount of tech company loans trading at distressed levels surged by $17.7 billion in the past four weeks, reaching the highest level since October 2022.
Amid the rout, private credit funds managed by Oaktree and Ares told investors that they have written off the equity stakes they held in educational-software business Pluralsight just 18 months after lenders took over the company.”
February 4 – Bloomberg (Dorothy Ma and Rachel Graf):
“A selloff in software debt has pushed billions of dollars of loans into distressed territory, rapidly repricing a market amid the threat of AI disruption.
More than $17.7 billion of US tech company loans in a Bloomberg index dropped to distressed trading levels during the past four weeks…
That figure, which swells the total tech distressed debt pile to about $46.9 billion, is dominated by firms in software-as-a-service, or SaaS, an industry seen as particularly vulnerable because AI is supplanting tasks like writing code and analyzing data.”
February 5 – Financial Times (Eric Platt and Antoine Gara):
“Shares of US private capital giants Ares, Blue Owl and KKR slid after they warned rising market volatility over fears of AI disruption could slow fundraising and delay asset sales until 2027.
US markets have been roiled by a sharp sell-off in technology stocks as investors worry AI tools could lead to the broad obsolescence of many software businesses, undercutting a core asset class for private capital investors over the past decade.
The volatility is causing groups to consider delaying asset sales that would allow them to generate lucrative performance fees or cause overall asset growth to slow as investors pull money from some funds or delay making new investments.”
February 4 – New York Times (Maureen Farrell):
“Private credit, an industry focused on lending to risky companies, has been one of the fastest-growing sectors on Wall Street, raking in trillions of dollars of investments and minting a slew of billionaires.
But the tide has started to turn.
Blue Owl Capital, the largest private credit firm, has seen its stock fall more than 50% over the past year — including a 10% drop on Tuesday — and investors have been pulling money from funds that the firm manages.
Apollo Global Management and BlackRock… have also rattled investors with write-downs on large loans to several troubled e-commerce companies.
Concerns about risks in the industry have been rising for months after a smattering of loan losses have raised questions about the financial stability of private credit borrowers.”
Leveraged loan prices dropped 0.6 points this week to 95.40 – the low since April 22nd, along with the largest weekly drop since liberation day “risk off.”
Importantly, high-risk lending was vulnerable ahead of “SaaSpocalypse.”
The marketplace is now well past peak confidence/complacency.
Speculative flows have reversed away from private funds, “business development companies” (BDC), and leveraged lending more generally.
The upshot is newfound vulnerability to negative developments.
Under the headline, “The $3 Trillion AI Data Center Build-Out Becomes All-Consuming For Debt Markets:” February 2 – Bloomberg (Paula Seligson):
“More than $3 trillion.
That’s the staggering price tag to build the data centers needed to prepare for the artificial intelligence boom.
Not even the world’s biggest technology companies—not Amazon.com, not Microsoft or Meta Platforms—are prepared to foot the bill with only their own cash.
The massive equity investments in private companies such as OpenAI and Anthropic don’t come close to this Industrial Revolution-size cost.
And government payments and subsidies can ease the financial burden only so much.
So where will the money come from?
Debt markets.
Which ones?
All of them.
Blue-chip bonds, junk debt, private credit and complex asset-backed pools of loans.
‘The numbers are like nothing any of us who have been in this business for 25 years have seen,’ says Matt McQueen, who oversees global credit, securitized products and municipal banking and markets at Bank of America Corp.
‘You have to turn over all avenues to make this work’.”
Market dynamics were this week reminiscent of incipient April instability.
Specifically, correlations between leveraged lending and technology stocks quickly manifest as a major market issue.
Overhanging the market is the $3 TN AI buildout, which will require unprecedented bond issuance and risky lending.
And the marketplace has begun to recognize the harsh reality that borrowing requirements will be massive and ongoing, but much of the borrowing will also be of high-risk variety.
Profound AI arms race ambiguity turned more tangible this week.
February 2 – Bloomberg (Debby Wu):
“Nvidia Corp. Chief Executive Officer Jensen Huang said the company’s proposed $100 billion investment in OpenAI was ‘never a commitment’ and that the company would consider any funding rounds ‘one at a time.’
‘It was never a commitment,’ Huang told reporters...
‘They invited us to invest up to $100 billion and of course, we were, we were very happy and honored that they invited us, but we will invest one step at a time.’
As part of a letter of intent signed in September, Nvidia said it planned to invest as much as $100 billion in OpenAI to support new data centers and other artificial intelligence infrastructure.”
February 2 – Wall Street Journal (Jonathan Weil):
“The likelihood that Nvidia will be investing far less than $100 billion in OpenAI raises big questions for Oracle.
Foremost are whether the ChatGPT developer can make good on its five-year, $300 billion contract with Oracle, and whether the tech giant should really be recording the full amount of that deal on its own books.
As of Nov. 30, Oracle reported $523 billion of remaining performance obligations, which represent contracted sales not yet recognized as revenue.
The figure, which is a closely watched footnote disclosure, was about nine times Oracle’s revenue for the previous four quarters, and included the $300 billion related to OpenAI.”
Future AI cash flows and profits remain highly uncertain, while widespread problematic disruptions are a certainty.
Both new and existing debt will become a pressing issue.
Worse yet, this unprecedented surge in suspect borrowings comes so late in the Credit cycle.
I often discuss how “terminal phase excess” promotes a parabolic rise in systemic risk.
Suddenly, this insidious dynamic turns conspicuous.
February 2 – Bloomberg (Rene Ismail):
“Private credit could see default rates surge to as high as 13% in the US if artificial intelligence triggers an ‘aggressive’ disruption among corporate borrowers, according to UBS...
The asset class is more exposed to AI risk than the markets for leveraged loans and high-yield bonds, which could see default rates rise to as high as 8% and 4%, respectively, in an aggressive disruption scenario, UBS strategists including Sachin Ganesh wrote…
AI disruption fears are accelerating weakness in credit globally, as investors grapple with the prospect that it renders existing business models obsolete.
The impact is more outsized in leveraged finance markets…, noting US high-yield tech spreads have widened by more than 90 bps despite the broader index tightening.
US leveraged loans in the tech sector have also dropped…
‘We attribute at least part of this underperformance to markets pricing in a disruption risk premium for pockets of the sector,’ the strategists wrote.
‘It is still too early to say when exactly AI disruption plays out at scale, but we believe that the trend is set to accelerate this year’.”
February 3 – Reuters (David French and Isla Binnie):
“Disruption to businesses from artificial intelligence development is ‘top of the page’ for Blackstone, the world’s largest alternative asset manager, its president and chief operating officer Jon Gray said…
‘You want to be thinking about this in almost everything you’re doing now,’ Gray told the WSJ… event…
Blackstone manages assets worth $1.27 trillion, spanning most sectors of the economy across the world.
Some of its portfolio, including sandwich shops and apartment complexes, are ‘less at risk’, Gray said.
But other businesses face much more serious questions, he added, citing an insurance firm lowering rates for customers using self-driving cars.
‘You start to say, well, what does that mean for collision repair?
What does that mean for auto insurance?
What’s going to happen to all sorts of rules-based businesses?’ he said.
Along with other large private capital firms, Blackstone has invested heavily in the infrastructure around AI…”
Keep in mind that, unlike stock speculators, lenders and bond investors don’t enjoy big upside returns in the event of a successful AI build out.
They, however, will be on the hook for big losses when this historic Bubble bursts.
The unattractive AI debt market risk vs. reward calculus is coming into clearer view.
As risk aversion takes hold and speculative deleveraging gains momentum, a most inopportune tightening of financial conditions will strike at the heart of a fragile Credit market.
Scores of levered and uneconomic enterprises risk getting cut off from new finance, as the Credit cycle’s fateful downside gains momentum.
It’s increasingly difficult to ignore serious Credit market developments.
All eyes on the leveraged speculating community.
Major crypto losses have unleashed a problematic deleveraging.
We can assume enormous amounts of speculative leverage permeate technology stocks, ETFs, and related derivatives.
This week saw the start of de-risking/deleveraging in big tech.
Meanwhile, acute volatility along with extraordinary performance dispersion between sectors suggests the unwind of hedge fund “pairs trades” and derivatives bets.
February 6 – Bloomberg (Justina Lee, Lu Wang and Jan-Patrick Barnert):
“The turmoil unleashed in stocks this week by worries about the impact of artificial intelligence has rattled a slew of hedge fund strategies that had been enjoying a strong start to 2026.
As one of the wildest rotations in years scrambled the equity leaderboard, both fundamental and systematic long-short hedge funds posted the worst day since at least November on Wednesday, according to… Goldman Sachs…
Multi-strategy equity portfolios suffered the worst session since April…
‘Wednesday’s moves severely impacted all equity strategies simultaneously with more than two thirds of funds in each index down,’ wrote a Goldman team led by Vincent Lin.
‘Last time all three strategies were down more than 75 bps in a single day happened during Covid sell-off’.”
In a world with unprecedented speculative leverage, every incipient speculator deleveraging now flags the issue of “basis trade” and Treasury market leverage.
One of these days…
February 5 – Bloomberg (Edward Bolingbroke and Michael MacKenzie):
“A highly leveraged hedge fund strategy is flashing signs of strain amid concern that a potential shift in Federal Reserve balance-sheet policy and broader risks could fuel renewed volatility in bonds.
The trade, essentially a bet that Treasuries will outperform similar-maturity interest-rate swaps, widening the yield gap between the two, has come under pressure this week in the long end of the curve.
Spreads there have narrowed to their tightest since mid-December.
Some market watchers say the move bears the hallmarks of early deleveraging in crowded widener positions, which had delivered strong gains since rebounding from April’s tariff-driven selloff.
‘There’s been a long march wider in 30-year swaps spreads from last year, and that trade is coming down a little bit,’ said George Catrambone, head of fixed income at DWS Americas.
‘There’s probably some deleveraging going on and unwinds,’ and the sector is prone to ‘less liquidity’ at times as there’s a limited number of players in the market that far out the swaps curve, he added.”
February 4 – Bloomberg (Greg Ritchie):
“The world’s top financial stability watchdog has urged policymakers to more closely scrutinize the multi-trillion dollar leveraged bets on government bonds popular with hedge funds and other investors.
The Financial Stability Board pushed for more oversight of the risks being taken on by market participants in repurchase agreements, or repos, backed by government bonds.
In a report… it identified and outlined several ‘vulnerability metrics’ that regulatory authorities can track ‘in order to strengthen surveillance capabilities.’
Hedge fund cash borrowing in repo markets has increased over the past few years, with FSB calculations putting it at $3 trillion — or 25% of their assets.”
The analysis of vulnerable Bubbles in Credit, AI, leveraged speculation, and global risk assets at the precipice is compelling.
De-risking/deleveraging and a problematic tightening of financial conditions appear likely if not imminent.
Objectively, however, general financial conditions remain extraordinarily loose.
Investment-grade CDS ended the week at 50 bps (up 1bp for the week), with high yield CDS at 301 bps (5 higher).
These levels suggest neither risk aversion nor waning liquidity.
At 266 bps, high yield spreads-to-Treasuries compares to the one-year average of 294 bps – and is significantly below the April spike to 450 bps.
I’ll note again last week’s $85 billion surge in money market fund assets.
Complicating the analysis, fledgling de-risking/deleveraging is unfolding in a global market environment rife with liquidity overabundance.
It’s unclear if it’s “basis trade,” Treasury swaps-related, global “yen carry trade” leverage, or all the above.
But there remains some source stoking global liquidity excess.
This tug-of-war between upside liquidity dislocation and intensifying speculator deleveraging seemingly ensures ongoing volatility and breathtaking monetary disorder.
I expect this clash to break toward “risk off” deleveraging and tighter conditions.
Timing uncertain.
0 comments:
Publicar un comentario