A look at the macroeconomic data, which indicates how Israel is perceived by investors can be misleading. There is a series of data pointing to serious concerns on the part of investors, while there is the shekel-dollar exchange rate, and the Tel Aviv Stock Exchange (TASE) which convey a sense of relative stability, even though the security situation has been escalating day by day.
Let's start with the risk factors. Firstly, the risk premium on Israel's ten-year government bonds in terms of CDS (credit default swap), an instrument that contains the cost of insurance against the fear that the State of Israel will not be able to repay its debts, jumped to a higher level than even at the beginning of the war. As of today, it stands at close to 180 points, a 12 year high.
In addition to this, even when you look at the 10-year dollar bond spreads, you get a worrying picture. The base point is the ten-year US bond, which is considered a "risk-free asset", and the spread is the difference between the returns that investors demand. In simple words, if the US bond yields 3.8%, the investors for the Israeli bond yield 2% more. For comparison, these are very high risk levels typical of countries like Mexico.
The local bond market is also signaling distress. The yield on the ten-year shekel bond crossed the 5% mark in recent days and reached a two-month high. That is, investors demand a higher yield as compensation for taking on higher risk. Unlike stocks, government bonds behave directly according to the state of the Israeli economy. For example, the Tel Gov-Shekel 10+ index, which includes the government's bonds furthest from maturity, and is therefore the most dangerous index from the point of view of investors, traded at an implied yield to maturity of 5.32% on Wednesday.
The factors stabilizing the shekel
On the other hand, and surprising in a certain sense, there is the shekel-dollar exchange rate. If we look at the Bank of Israel representative rate on the eve of the war, October 6, it stood at NIS 3.86/$. Today, the representative rate stands at 3.75/$. Why is this surprising? Until a few months ago, the market estimated that an escalation on the northern front would lead to a significant jump in the exchange rate, even up to the level of NIS 4/$, as we saw at the beginning of the war. Although there has been some depreciation in recent days, it has not been dramatic. The volatility is also not sharp, unlike in the early days of the war, nor during the struggle over the government's proposed controversial changes to the judicial system last year.
How can this be explained? There are several reasons. Firstly, the role of the Bank of Israel. At the beginning of the war it launched a major plan to sell up to $30 billion from its over $200 billion of foreign exchange reserves. In the first weeks, the bank did sell about $8.5 billion, which strengthened the shekel. Since then, the rate has remained more or less stable, moving between NIS 3.5-3.8/$. The very fact that the market knows that the Bank of Israel is there in the background with its large foreign exchange reserves, plays its part.
A second reason is the correlation between what is happening on Wall Street and the shekel. The rule of thumb that was true until the judicial reform battle was that as the stock market in the US rises, the shekel strengthens. The reason: the need for Israel's institutional investors to hedge their investments. The strong performance of the US markets this year also supports the strengthening of the shekel. The assumption is that even if the correlation does not function as in the past due to the geopolitical risks, it is still influential.
Finally, there is the role of foreign investors who during crises are expected to be the first to leave. The assumption in the market is that a substantial part of them left the market at the beginning of the war, and those that remained have simply got used to the reality over the past year. However, it should be noted that according to many estimates, including those previously presented by the Bank of Israel, had it not been for the war and the domestic political crisis in 2023, the shekel would have been significantly stronger today. It is difficult to estimate exactly how much, and estimates can reach NIS 0.30-0.40 per dollar.
"Drawing optimism"
IBI Group's Four Season chief investment officer Robert Carmeli tells "Globes," "As things current look, Israel's holds the reins and is controlling the tone. This, while Hezbollah is maintaining a relatively restrained response. It can be assumed that investors derive from this optimism about the future. No less important than that, the sequence of blows that Israel landed on the terrorist organization moderates the catastrophe scenario that was wafting in the air regarding the outbreak of war in the north."
Carmeli refers to both the shekel-dollar exchange rate and the performance of the TASE, which this week has shown a series of gains despite the expansion of the campaign against Hezbollah. According to him, one of the reasons for this is the "positive momentum in the US after a relatively aggressive interest rate reduction, which has contributed its part to breaking records on Wall Street."
He adds, "It should be remembered that the domestic market is lagging behind other markets, having recorded major underperformance. So as long as there is an opportunity and a little optimism to reduce the gaps, we see it happening - albeit gradually and in accordance with the unfolding developments on the northern front."
Bank Hapoalim research unit director Yaron Friedman warns that, "A larger scale war, both in the scope of fighting and amount of damage on the home front, if it happens, is something whose impact would be much worse in terms of both the stock market and the exchange rates."
Published by Globes, Israel business news - en.globes.co.il - on September 26, 2024.
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