US Stock Market Danger Signals Flashing! $1.5 Trillion in Leverage Could Intensify Market Volatility

With oil prices remaining high and Middle East conflicts unresolved, the artificial intelligence (AI) theme that has supported the US stock rally is beginning to cool, causing multiple market warning indicators to approach dangerous levels again. Investors are not only questioning the profitability and cash burn of AI investments but also facing risks from rising long-term US Treasury yields, record-high margin debt, and the potential reversal of yen carry trades.

After attacks in the Persian Gulf paused, international oil prices fell from around $100 per barrel but remain high enough to push up inflation, keeping long-term government bond yields at elevated levels typically unfavorable for risk assets. At the same time, the nearly unstoppable rise in AI-related stocks has begun to be suppressed by concerns over profit prospects, cash consumption, and the possibility of semiconductor supply shifting from shortage to surplus.

Despite the cooling of AI trading and rising US Treasury yields, leverage in US stocks has hit a record high. While tech company earnings remain strong, investors are no longer focusing solely on current revenue but demanding proof that massive investments in AI data centers and chips will translate into revenue and profits sufficient to justify valuations.

As markets anticipate the Federal Reserve (Fed) may raise interest rates this year, corporate bond yields for large-scale AI cloud service providers are rising faster than US Treasuries, reflecting the market's demand for higher risk compensation. The cost of hedging against credit deterioration has also clearly increased, coinciding with semiconductor stocks losing momentum, further amplifying market anxiety.

On a more positive note, the Nasdaq futures long-short ratio has dropped to a 17-year low, indicating investors have significantly pulled back from tech stocks—potentially creating room for future capital inflows.

However, leverage risk behind the US stock rally continues to rise. According to data from the Financial Industry Regulatory Authority (FINRA), margin debt—funds borrowed by investors to buy stocks—rose to a record $1.5 trillion in June. Cash net positions in investor brokerage accounts have also recorded a $1 trillion deficit for the first time.

When investors owe more to brokers than they hold in cash, they are more likely to be forced to sell stocks during price declines rather than buying the dip, potentially amplifying market corrections.

The US 30-year Treasury yield has also remained above 5%, the longest such period since the early stages of the 2007 financial crisis. While 5% alone may not directly trigger a stock sell-off, persistently high long-term rates push up mortgage and corporate financing costs, suppressing consumer spending.

Larry Adam, Chief Investment Officer at Raymond James, pointed out that credit spreads on some of the riskiest corporate bonds have risen to a 15-month high, showing that investors are becoming more selective toward weaker borrowers amid Fed tightening and deteriorating economic conditions.

Oil Price Shock Hits Global Importers—Yen Carry Trade Could Be the Next Bomb

Although international oil prices have fallen below $100 per barrel, they are still 27% higher in dollar terms than a year ago. This benefits US energy producers but imposes heavier inflation and cost pressures on other oil-importing nations.

Importers in the Eurozone and the UK are paying nearly 30% more for oil than a year ago; Indian refiners face a 40% increase in costs for crude linked to Brent oil, while refiners in Argentina and Turkey see costs rise by nearly 50%. Japan, due to yen weakness and rising energy prices, has seen import values climb to a record high.

Shipping costs have also surged. With vessels facing security risks when passing through the Strait of Hormuz and the Red Sea, tanker freight rates on key Middle East-to-Asia routes have skyrocketed about 600% year-on-year, potentially further pushing up energy and commodity prices.

Another risk stems from the yen. The yen has fallen to near 164 per dollar, touching a 40-year low, sparking market concerns that the Japanese government might intervene. Despite rumors that the Bank of Japan (BOJ) is considering accelerating rate hikes and repeated warnings from Finance Minister Shunichi Suzuki, the yen remains difficult to support.

Relatively low Japanese interest rates and the yen’s historically low volatility have made it a key funding currency for carry trades. Investors borrow low-cost yen to invest in higher-yielding assets like US stocks and bonds. If the Japanese government intervenes in the currency market, triggering a sharp yen appreciation, investors may be forced to rapidly unwind positions, potentially re-creating the kind of market turmoil seen during the large-scale carry trade unwinding in August 2024.