Dollar Steady as U.S. Debt Ceiling Deal Likely

• Reports suggest a deal has been struck to extend the debt ceiling; markets are looking for a solid September jobs report Friday; Mexico reports September CPI; Peru is expected to hike rates 50 bp to 1.5%.
  
• Reports suggest the ECB is studying a new bond-buying program to help maintain orderly markets when PEPP ends next year; ECB publishes the account of its September 9 meeting; ECB PEPP purchases for the week ending October 1 fell sharply; President Macron will reappoint Villeroy as the Governor of the Bank of France; Poland joined the hawks with an unexpected 40 bp hike to 0.5%; Israel is expected to keep rates steady at 0.10%
  
• BOJ downgraded the outlooks for most of the regional economies in the so-called Sakura report; new Finance Minister Suzuki made his first comments about FX; energy prices took a sharp dip on a series of supply side news
  

The dollar is holding on to its gains even as risk-on sentiment builds from reports of a likely debt ceiling deal. DXY is down marginally near 94.20 after two straight up days, which supports our view that recent dollar gains were not just from risk-off demand that shook markets this week. The euro remains heavy after trading yesterday at the lowest level since July 2020 near $1.1530. Sterling is holding up better but is having trouble moving back above $1.36. Lastly, USD/JPY is trading near 111.50 and is on track to test last week's high near 112.10. Markets may remain in recent ranges ahead of jobs data tomorrow.

AMERICAS

Reports suggest a deal has been struck to extend the debt ceiling. Senate Minority Leader McConnell is offering a short-term extension through November that increases the ceiling by a fixed amount so that default is averted. This is being offered so that the Democrats can pass a more lasting increase via the budget reconciliation process, which experts say would take about two weeks. Senate Majority Leader Schumer has said that this process would take too long and so McConnell is calling his bluff. Reports suggest the Democrats are likely to accept this extension. If this works out, then the October 18 drop-dead date no longer holds and that's why markets are breathing a huge sigh of relief.

We have always been at a loss as to why the Democratic leaders insisted that the debt ceiling be increased by a bipartisan vote. The mood on Capitol Hill is downright hostile right now and neither party seems inclined to reaching cooperative solutions. The one exception is the traditional infrastructure bill worth $550 bln. Our best guess remains that the Democrats agree on a figure somewhere in the neighborhood of $2.5 trln for the "human infrastructure" bill and wrap it together with a debt ceiling increase that can be passed via budget reconciliation. Once that is passed, then the infrastructure bill will be passed with bipartisan support by the end of October or perhaps early November.

Markets are looking for a solid September jobs report Friday. Most of the clues so far have been good. The latest was provided by ADP yesterday, which reported private sector jobs rose 568k vs. 430k expected and a revised 340k (was 374k) in August. As one might expect, Bloomberg consensus for NFP has crept higher to 500k from 488k pre-ADP. Other solid clues were provided by the ISM PMI readings, as the employment components came in at 53.0 vs. 53.7 in August for services and at 50.2 vs. 49.0 in August for manufacturing. Jobless claims today are expected to show continued improvement, with initial claims seen at 348k vs. 362k previously and continuing claims seen at 2.762 mln vs. 2.802 mln previously.

We believe that the bar to tapering has gotten pretty low. Indeed, we feel that any reading above last month's 235k can be used as a trigger for a tapering announcement at the November 2-3 FOMC meeting. U.S. yields remain elevated, with the 2-year trading near 0.30% and the 10-year near 1.52%. A strong jobs report tomorrow would most likely keep upward pressure on yields. Mester speaks today. September Challenger job cuts and August consumer credit ($17.5 bln expected) will be reported as well. Elsewhere, Canada reports September Ivey PMI.

Mexico reports September CPI. Headline inflation is expected at 6.00% y/y vs. 5.59% in August. If so, it would be the highest since April and further above the 2-4% target range. Last week, Banco de Mexico hiked rates 25 bp for the third straight meeting to 4.75% and left the door open for further hikes. The vote was 4-1, with the lone dissent in favor of steady rates. Next policy meeting is November 11 and another 25 bp hike to 5.0% seems likely.

Peru central bank is expected to hike rates 50 bp to 1.5%. A minority see no hike or a smaller 25 bp move. The bank unexpectedly started the tightening cycle with a 25 bp hike to 0.5% August 12, then followed that with a 50 bp hike to 1.0% September 9. Last week, September headline inflation came in at 5.23% y/y vs. 4.83% expected and 4.95% in August. This was the highest since February 2009 and further above the 1-3% target range. As such, we lean towards a 50 bp hike to 1.5% today.

EUROPE/MIDDLE EAST/AFRICA

Reports suggest the ECB is studying a new bond-buying program to help maintain orderly markets when PEPP ends next year. The plan would be meant to replace PEPP and complement the existing AP, something Madame Lagarde has hinted at in the past. Officials said no decisions have been made and that the bank staff often discuss a wide array of policy options that aren't always presented to the Governing Council. Next policy meeting is October 28. While the fate of PEPP will surely be discussed then, Lagarde has tipped the December 16 meeting for a final decision on QE.

The ECB publishes the account of its September 9 meeting. While announcing that slower pace of QE then, the ECB stressed that PEPP will be used "flexibly" according to market conditions. Lagarde said that the "recalibration" was for the next three months, which suggests that if the recovery falters, the PEPP pace can be recalibrated again for Q1. So, there was a little bit for everyone. We suspect this meeting was very lively as the split between the hawks and doves was widening as inflation continued to rise.

ECB PEPP purchases for the week ending October 1 fell sharply. Net purchases were EUR8.2 bln, the lowest since January. Redemptions were a rather high EUR7 bln but the pace of net purchases is noticeably slower. That's to be expected after the ECB announced last month that the pace of PEPP buying in Q4 would run at "a moderately lower pace" than in past quarters.

French President Macron will reappoint Villeroy as the Governor of the Bank of France. There was some speculation that Macron might replace him but given that Villeroy is firmly in the dovish camp, that really didn't make much sense to us. His six-year term expires at the end of this month. If he is reappointed, then Villeroy would remain in place until 2027. ECB officials Elderson, Lane, Holzmann, and Schnabel speak today.

Germany reported weak August IP. It was expected to fall -0.5% m/m but instead plunged -4.0%. July was revised to a 1.3% m/m gain vs. 1.0% previously. This continues a string of weak German data. Yesterday, factory orders plunged -7.7% m/m and suggests little relief for IP in the coming months. Data will surely be viewed by the doves at the ECB as reason to maintain stimulus.

Yesterday, National Bank of Poland joined the hawks with an unexpected 40 bp hike to 0.5%. Poland is starting to play catch up to Hungary and Czech Republic, while isolating Turkey. The first hike since 2012 came as a surprise, with all of the analysts on the Bloomberg poll calling for no change. One of the most interesting twists of this story was the comment by Prime Minister Morawiecki calling for an "appropriate" response to the inflation threat. It's not every day that we see the government pressuring the central bank to raise rates. The zloty has outperformed on the move, up over 1% yesterday against the euro and tacking on a modest 0.1% gain today.

Bank of Israel is expected to keep rates steady at 0.10%. CPI rose 2.2% y/y in August, the highest since July 2013 and in the upper half of the 1-3% target range. At the last meeting August 23, the bank delivered a dovish hold, warning that the delta variant adds "a measure of uncertainty regarding economic activity in the short and medium terms" and it "will therefore continue to conduct a very accommodative monetary policy for a prolonged time." We believe that the policy rate along with the bank's FX intervention and bond-buying programs are all likely to remain in place well into 2022.

ASIA

The Bank of Japan downgraded the outlooks for most of the regional economies in the so-called Sakura report. Branch managers from five of the nine regions reported that their economies were worse off now compared to three months ago. The downgrades were due to a combination of supply chain issues and weak consumer spending. With the state of emergency just lifted, the latter issue should improve but supply chain issues continue to weigh on industry around the world, not just in Japan. Next BOJ meeting is October 27-28 and no change in policy is expected as the focus is on fiscal policy and the next stimulus package that is due out soon.

New Finance Minister Suzuki made his first comments about FX. Predictably, he said "There's no doubt that stability in currencies is important for the Japanese economy. I will be certain to keep monitoring movements in foreign exchange markets closely." As we all know, calling for stable exchange rates in Japan really translates into a desire for a weak yen. As things stand, USD/JPY traded last week at the highest level since early 2020 and has largely traded in a 102-112 range since early 2019. In other words, Japan policymakers shouldn't do anything to rock the boat.

COMMODITIES

Energy prices took a sharp dip on a series of supply side news. President Putin insinuated that Russia could increase gas exports to Europe. It's unclear whether he means it or is just trying to extract political capital in another form after sensing a local peak in the energy crunch. It's surely no coincidence that this change in tone comes right after the U.S. said it may release up to 60 mln barrels from its strategic reserves. Also, U.S. DOE inventory data showed an unexpected build in gasoline and oil inventories.

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