Rising Financing Rates and Worsening Liquidity: How to Rebuild Asset Allocation in the "New Order" by 2026

The current market faces a covert but deadly problem: financing rates have not declined as expected; instead, they have become the central driver of the liquidity crunch. Despite the Federal Reserve implementing three “defensive” rate cuts by 2025, long-term financing rates stubbornly remain above 4%, indicating that the overall cost of market financing is far higher than investors anticipated. This high-rate environment is profoundly changing the logic of global asset allocation—from the past two decades of “costly pursuit of efficiency” to a new order of “efficiency under safety constraints.”

Why Financing Rates Have Become the Catalyst for Liquidity Risks

Behind rising financing rates lie structural pressures within the U.S. financial system. Although the Fed announced the end of quantitative tightening in 2025, bank system cash flows have become even tighter. This seemingly contradictory phenomenon stems from deep changes in the financing structure.

This is evident in the behavior of the effective federal funds rate (EFFR). In a liquidity easing environment, the EFFR typically hovers near the lower bound of the interest rate corridor; but since October 2025, the EFFR has gradually moved toward the midpoint of the corridor, eventually crossing over to drift toward the upper bound. This is not a sign of abundant liquidity—in fact, it indicates increasing financing pressures faced by banks.

A more telling indicator is the spread between SOFR and the Interest on Reserve Balances (IORB). SOFR reflects the secured financing rate backed by U.S. Treasuries, while IORB is the interest paid by the Fed on bank reserves. When SOFR is significantly higher than IORB, it means that even with collateral, banks are willing to pay a premium to secure liquidity—an intuitive sign of financing rate pressure. Since October 2025, this spread has widened persistently without signs of narrowing, suggesting that high financing rates may become the norm.

The core issue is that high financing rates are causing banks to shrink their lending. Over the past year, commercial and industrial loans have declined significantly compared to 2024, and consumer credit remains weak. The liquidity that banks already have is prioritized for financial investments rather than real economy lending, which in turn raises the financing costs needed to sustain high market valuations.

The Vicious Cycle of U.S. Treasury Financing Rates and the Repurchase Market

Another dimension of the problem is the deterioration of the U.S. fiscal financing structure. As the U.S. debt surpasses $38.5 trillion, the Treasury is compelled to issue large volumes of short-term T-bills to access cheaper financing. While this temporarily lowers government financing costs, it comes at a heavy price: a rising proportion of T-bills often signals a decline in sovereign creditworthiness.

When investors begin to doubt the government’s repayment ability, the government relies even more on short-term financing, further increasing the share of T-bills—creating a vicious cycle. More critically, this over-reliance on short-term instruments shortens liquidity “lifespan.” Frequent rollovers and unstable financing structures, at a time when overall leverage has hit historic peaks, severely weaken market resilience.

To sustain high equity valuations, the repurchase (repo) market has become the market’s last “lifeline.” In 2025 alone, the size of the repo market surged from $6 trillion to over $12.6 trillion—more than triple the level during the 2021 bull market. These repo transactions typically use U.S. Treasuries as collateral, further boosting demand for long-term Treasuries and pushing up long-term financing rates.

In this cycle, high financing rates are no longer just a number—they have evolved into a systemic risk factor supporting high valuations. As leverage continues to grow, margin lending hit a record $1.23 trillion in December, up 36.3%. Investors’ net borrowing positions expanded to -$814.1 billion, in line with the growth of margin debt. This indicates that market tolerance for financing costs is waning, and potential chain liquidations are already lurking.

Rising Risk Premiums: Portfolio Reallocation Must Shift to “Hard Assets”

High financing rates and deteriorating liquidity quality directly lead to an increase in systemic risk premiums. Although policy rates have been cut by 75 basis points, the 10-year U.S. Treasury yield—long-term financing’s benchmark—has only fallen by 31 basis points, meaning long-term rates remain stubbornly high.

In this environment, when the implied forward return of a risk asset falls below the yield of Treasuries, holding that asset long-term becomes unattractive. Cryptocurrencies are particularly sensitive— as implied returns decline, investors gradually reduce exposure, and markets inevitably enter a correction phase.

Compared to expensive long-term financing, short-term funding via T-bills is much cheaper. This creates a natural environment conducive to speculation: investors tend to “borrow short, leverage high, and trade quickly.” While markets may look lively in the short term, such speculative bubbles are hard to sustain—this is vividly reflected in crypto markets, which are highly sensitive to financing rate fluctuations.

Meanwhile, investors’ allocation logic is undergoing a fundamental shift. The year 2025 has seen a return to “strict diversification”: liquidity is no longer confined to dollar assets but dispersed across a broader range of assets. Assets tightly linked to the dollar (such as cryptocurrencies and WTI crude oil) underperform, while assets with lower dollar correlation (like precious metals) outperform other major asset classes. Even holding euros or Swiss francs shows performance comparable to the S&P 500—indicating that investor reasoning has moved beyond single-cycle considerations.

Three Key Certainties in the Regionalization Era: Resources, Computing Power, Security

The most important reevaluation in 2026 is not whether growth remains strong, but that markets are adopting a new pricing framework. The two main assumptions that supported global returns—“extreme efficiency of global supply chains” and “central banks’ unlimited backstops”—are breaking down. Instead, a “regionalization” paradigm is emerging, shifting from “costly efficiency” to “efficiency under security constraints.”

Under this new order, asset allocation is no longer about betting on a single direction but about recalibrating exposure to three “hard variables”: supply constraints, capital expenditure, and policy-driven order flows.

First: resource allocation. In a security-first era, increasing inventories of commodities (gold, silver, copper) even when not immediately needed is rational. Commodities are no longer just mirrors of the business cycle but are gaining attributes of “supply-constrained assets.” Options markets show that, despite some overheating signs in certain non-ferrous metals, traders generally expect gold to have further upside over the long term.

This logic also supports resource-based equities. Copper (e.g., Chile) reflects the rigid demand from electrification and industrial infrastructure; precious metals (e.g., South Africa) have both upward commodity potential and risk premiums. These should be viewed as genuine “supply-constrained factors” in portfolios.

Second: AI infrastructure. The focus should return to balance sheet fundamentals: computing power, energy, data centers, and cooling systems. Instead of chasing application-layer narratives, lock in long-term returns from new physical infrastructure. Markets like South Korea, with their visible capital expenditure and policy support in the semiconductor and electronics sectors, are direct beneficiaries of the AI capital expenditure cycle.

Third: Defense and security. Due to normalized geopolitical tensions, defense spending has become a rigid fiscal function constrained by national security. While volatile, this sector plays a key “tail risk insurance” role in portfolios. Additionally, the valuation and low correlation of Hong Kong stocks and Chinese assets with Western markets offer scarce hedging value in a regionalized world.

The New Game of the Yield Curve and Term Premiums

The core contradiction in the 2026 interest rate market is that the front end of the curve is more influenced by monetary policy paths, while the long end acts more like a “container” for term premiums. Expectations of rate cuts do help lower short-term financing rates, but whether long-term yields decline in tandem depends on inflation tail risks, fiscal pressures, and political uncertainties that may prevent further compression of term premiums.

In other words, the stubbornness of the long end does not necessarily mean the market has mispriced rate cuts; it may also reflect a re-pricing of long-term risks. Supply dynamics will further amplify this structural divergence. When the money market has capacity, short-term financing tools are more easily absorbed; in contrast, the long end is more prone to “pulses” driven by risk budget constraints and shifts in term premiums.

For portfolios, this means duration exposure should be managed in layers, avoiding bets on a single path—such as “complete inflation disappearance and term premium returning to ultra-low levels.” Curve-structuring trades (like steepening strategies) persist not only because of trading skill but because they align with the different pricing mechanisms of short- and long-term financing rates.

Cryptocurrencies’ Turning Point: Bitcoin vs. Equity Tokens

2026 marks a watershed for crypto markets. Bitcoin (BTC) has already surged past $69,050 (up 4.65% in 24 hours), with a market cap of $138.032 billion, reflecting recognition of Bitcoin’s role as a “hedge tool.”

As a non-sovereign, rule-based “digital commodity,” Bitcoin is more easily accepted as a payment alternative and risk hedge under regionalization narratives. Its fixed supply property aligns it with other supply-constrained assets.

In contrast, equity-like tokens behave more like high-risk assets. In an environment with still-uncertain regulation and high risk-free yields, they must offer substantial risk premiums to justify allocation. The fates of these two asset classes will diverge sharply.

Therefore, crypto asset allocation should adopt a “segregated management” approach: place Bitcoin within the commodities and hard assets framework, capturing convexity with small weights; treat equity-like tokens as high-volatility, high-risk assets, setting stricter return thresholds, and only allocating when risk premiums are sufficiently high.

Hard Constraints and Structural Opportunities in 2026 Portfolios

In summary, building a 2026 portfolio hinges on managing a series of “hard constraints,” rather than solely relying on macro forecasts. This requires proactive adjustments across several dimensions:

Hard Asset Allocation: Reinstate strategic positions in commodities and resource equities to address global supply bottlenecks, leverage AI infrastructure capital expenditure for visible profitability, and rely on defense sector policy orders to enhance resilience. These assets are driven by supply constraints, not just cycles.

Adapting to Financing Costs: As high financing rates become the norm, investors need to reassess the minimum risk premiums for each position. In a high-rate environment, low-volatility, high-dividend assets are more attractive; volatile speculative assets require higher expected returns to justify their inclusion.

Managing Term Premiums: Adjust to the reversion of term premiums affecting bond return distributions, selecting fixed income assets across different maturities and regions, rather than simple “bear steepening” trades. Use valuation differentials in non-U.S. assets for structural hedges.

Structural Opportunities: In a regionalized era, the most scarce skill is reducing reliance on “perfect prediction.” Let hard assets absorb structural demand, let the yield curve absorb macro divergence, and let hedge factors absorb market noise. The trading philosophy in 2026 is no longer about “guess the answer” but about “accept constraints”—and accordingly, radically resetting asset allocation priorities.

This is the investment approach in a high financing rate environment: do not fight liquidity, do not chase perfect timing—simply understand the constraints clearly, and seek structural opportunities within those bounds.