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Why the Fed’s “Overflow Drain” Running Dry Could Be the Next Big Risk 

• The Fed’s overnight reverse repo (RRP) facility has collapsed from $2.4 trillion to just $28.8 billion — a signal the liquidity buffer is nearly gone.
  
  
• With the RRP drained, pressure shifts to bank reserves, raising the risk of tighter credit, repo stress, and sudden cracks in financial markets.

What you need to know: The Fed’s overnight reverse repo (RRP) facility is nearly empty. Balances have collapsed from a $2.4 trillion peak in 2023 to just $28.8 billion today - the lowest in over four years. Citigroup even calls “empty” anything between zero and $20 billion. We’re basically there¹. 

Why it matters: Think of the RRP facility like the Fed’s overflow drain. When banks and money-market funds had too much cash, they parked it there overnight because they didn’t know what else to do with it. And as long as the drain had water in it, the banking system had a cushion of liquidity. But with that drain now almost dry, the system turns to bank reserves instead. Less RRP use = fewer excess reserves = tighter banking liquidity = shake confidence in financial markets and lead to market cracks. 

Now the Deep Dive: The overnight reverse repo facility - one of the most critical gears in the financial system - is ignored by most.

Few follow it. Fewer understand it. Maybe that’s because it’s wrapped in jargon and complexity, the kind of thing that makes people look away when they should be paying attention.

And over the past two years, no one cared as the money bled out. But here’s the truth - this isn’t some random “pipes and valves” detail. It’s the plumbing that keeps banks breathing.

And when the pipes run dry, things tend to break. I wrote about this back in early 2024 in “A Dive into the Overnight Reverse Repo Market and the Cracks Within.” But here’s the quick gist of what a nearly empty RRP means today:

• Cash shifts out of RRP - The Treasury keeps issuing mountains of short-term debt (T-bills) to finance deficits. Money-market funds, hunting for yield, pull cash from the Fed’s overnight facility to buy those bills instead. Think of it as the government’s debt acting like a suction pump - pulling money away from the Fed.
  
  
• The buffer disappears - For the past few years, the RRP acted like a sponge that soaked up excess liquidity. When it held trillions, it gave the financial system a wide safety margin. But now, with balances hovering around zero (below $30 billion as of writing this), that sponge is becoming bone-dry. Thus, there’s no slack left in the system.
  
  
• Reserves get tapped - From here on out, every dollar of demand for cash comes straight from bank reserves - the balances banks hold at the Fed that grease the whole machine. Think of reserves as the banking system’s gas tank - the Fed fills it when it wants to stimulate and drains it when it wants to tighten. Thus, as long as the tank has fuel, markets can run. But when the needle drops too close to empty, engines start sputtering. The point is, reserves are the cushion that lets banks lend, settle payments, and keep repo markets functioning smoothly.
  
  
• Liquidity tightens - On paper, reserves still look huge at about $3.3 trillion. But the number itself doesn’t matter. What matters is the cushion. How much can shrink before banks get nervous? Some Fed insiders whisper that the pain threshold is around $2.7 trillion, but no one really knows. Cross that invisible line and banks can begin panicking. They hoard cash. Lending slows. Repo markets seize up. And liquidity disappears at the exact moment the system needs it most.

For context, recall September 2019 - aka the “September Squeeze” event². Repo markets blew up almost overnight when reserves slipped “too low.” Overnight lending rates spiked to 10%, banks froze, and the Fed had to rush in billions to keep the pipes from bursting. Back then, reserves still looked “ample” - until they weren’t.

That’s the risk here. The reverse repo facility was the canary in the coal mine. With it now dry, the system has lost its buffer. Every drain on cash from this point cuts straight into reserves.

The point is, U.S. banking liquidity is at risk. Think of it like a dam that once held back excess water. As long as the dam was full, the canal below flowed steadily. But now that the dam has run dry, the canal itself is being drained - and that’s the water the whole system depends on.

And history shows markets don’t send out courtesy notices when the water runs dry - they just crack like a dried-up riverbed

I will keep you updated on bank reserves going forward.

Figure 1: St. Louis Federal Reserve, August 2025

AI Data Centers Set to Surpass Office Construction - Fueling Growth And Risking Oversupply

• Data center construction has surged +115% since early 2023, while office construction has fallen –22%.
  
  
• AI-driven infrastructure spending added a full point to Q1 2025 GDP growth – the biggest boost since the dot-com boom.

What you need to know: Data centers are on track to overtake office buildings in U.S. construction - a clear signal of the economy’s next phase of investment. 

Why it matters: The surge in data centers underscores the economy’s bet on digital infrastructure - the cloud, AI, and the insatiable need for processing power. But like every boom, it carries the seeds of its own undoing. Capital is flooding in, projects multiplying, and supply risks outrunning demand. Just as office towers once stood as monuments of endless growth before collapsing under overcapacity, today’s wave of data centers could tip into glut if expectations overshoot reality. 

Now the Deep Dive: In classic bubbly market fashion, AI data center construction screams “go big or go home.”

Since 2020, growth has been staggering. But the last 2.5 years is where things really exploded.

For example - as the chart below shows, over the past 2.5 years:

• Data center construction: +115%
• General office construction: –22%

At this pace, the value of data centers under construction will surpass offices within six months.

• For perspective: in 2022, office construction spending was 7x larger than data centers. Now, data centers are about to take the lead.

Of course, this shouldn’t surprise anyone.

Office spaces were grossly overbuilt after 2012, then gutted by COVID. Vacancy rates sat above 20% in Q1 2025 – aka one in five units empty³. And many of these projects are now stuck with huge debts coming due while property values plunge.

• See my 2024 piece “The Commercial Real Estate Crunch” for more context if interested.

Meanwhile, AI is white hot. Companies like Amazon, Meta, Microsoft, Oracle, etc are pouring hundreds of billions into its infrastructure. And as I wrote back in June in “AI Infrastructure Boom: How Data Centers and Uranium Power the Fourth Industrial Revolution” - AI-driven related construction added a full percentage point to Q1 2025 GDP growth. That’s the biggest boost since the dot-com boom - more than 8x the average impact of spending over the past decade.

Put simply, general office real estate is in a bust and deleveraging cycle, while AI infrastructure is in a boom and leveraging cycle.

And while this is exciting - I have to wonder:

Will all this massive capex pay dividends, making AI the new backbone of U.S. growth?

Or, like office towers before them, are we overbuilding data centers - only to face a reckoning once returns don’t match the hype?

History shows us that today’s booms are tomorrow’s busts. And tomorrow’s busts are the seeds for the next boom.

• This is known as the “capital cycle” – and I believe it’s one of the most under-discussed things in the investing world (we wrote about It back in February in case you want to learn more - read here).

Either way, even if half these data centers end up as empty shells, the spending is real and it’s adding to GDP now.

Just something to keep in mind.

Figure 2: Haver Analytics, August 2025 

From Job Cuts to Pay Cuts: China’s Labor Market Weakness Signals Bigger Deflation Ahead

• Youth jobless rate soars to an 11-month high as 12 million new graduates flood a fragile labor market — further eroding consumer confidence, wages, and growth.
  
  
• Falling incomes deepen deflation risks, but the weakness almost guarantees more stimulus — already giving Chinese equities a boost.

What you need to know: China’s youth jobless rate climbs to 17.8% - an 11-month high - as a wave of new graduates flood an already shaky labor market⁴. 

Why this matters: China’s record youth unemployment isn’t just a labor market story - it’s a confidence story. A generation of graduates who were told education was the ticket to prosperity are now stuck in a queue with no jobs at the end. That frustration bleeds into consumption, housing demand, and even social stability. When over 12 million new grads walk into the market and find only low-wage offers or none at all, it doesn’t just drag on growth - it erodes belief in the system itself. 

Now the Deep Dive: China’s labor market appears to be getting wobblier as the youth unemployment jumped to 17.8% in July from 14.5% in June - the sharpest rise in nearly a year.

And yes, every summer graduates flood the labor pool and push the numbers up. But this isn’t just about fresh graduates.

• The unemployment rate for those aged 25–29 also ticked up to 6.9% vs. 6.7%
• China’s overall jobless rate edged higher to 5.2% vs. three months at 5%

And while this is the headline point the mainstream is talking about – this is another symptom of a bigger disease.

For instance, the weak labor market is forcing workers to swallow steep pay cuts. Reports show Chinese employees across sectors facing 15–20% annual salary reductions - effectively a step backward in income⁵.

• Imagine you make $100,000, and next year your employer says, “You’ll get $80,000.” That’s a huge shock - and it cascades. Why? Because when household incomes are falling in real terms, consumers have less to spend.

From there the cycle turns further deflationary.

Businesses slash prices to out-sell competitors -> profits collapse -> hiring slows
-> wages fall further -> demand declines -> repeat as the spiral feeds on itself.

The upside here is that because of China’s dire economic circumstances almost guarantees greater government stimulus. And while stimulus has so far done little to restart real growth, it's lifted Chinese equity markets.

• Via SCMP: Premier Li Qiang has already called for stronger measures to boost consumption and investment after weak July data⁶.

How? Because more stimulus -> higher growth potential -> stronger forward expectations -> renewed confidence -> people start buying again -> pushes prices higher.

Remember, in markets, bad news often becomes good news.

China is living that paradox now. 

 Figure 3: SCMP, August 2025 

Anyway, who knows what will happen?

This is just some food for thought as we watch how these trends develop.

As always, we’ll be keeping a close eye on things.

Enjoy the rest of your weekend.

Sources:

1. Fed Reverse Repo Facility Use Sinks to Lowest Since April 2021 - Bloomberg
2. U.S._repo_market
3. U.S. Office Market Report August 2025 | CommercialCafe
4. China signals bolder policies to boost spending, investment as headwinds rise | South China Morning Post
5. Widespread pay cuts in China drive down consumer spending, fuel deflationary fears – Radio Free Asia
6. China signals bolder policies to boost spending, investment as headwinds rise | South China Morning Post

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