2022 saw the dollar strengthen against the world's major currencies as well as the shekel as the US Federal Reserve raised interests rates in an attempt to tame inflation. The Fed hiked rates faster than most other central banks and the US dollar benefitted from the interest rate gap and bigger returns available as well as its safe haven status in a time of uncertainty.
In 2022, the dollar strengthened 6% against the euro, 11% against sterling and 13.5% against the Japanese yen and just over 13% against the shekel, which ended the year at NIS 3.5228/$ having begun at NIS 3.11/$.
In recent months, however, the trend has changed with the US currency weakening against most currencies but not against the shekel. In December alone the US dollar lost 2% against the euro, 3% against the yen and 1.5% against sterling but gained 4% against the shekel.
According to Bloomberg, the DXY dollar index against the world's currencies had its worst quarter in the final quarter of 2022 since 2010 with a fall of 8% from its peak in September 2022. Despite that the DXY index rose 6% during 2022 for the dollar's best year since 2015.
There is a general consensus among Israeli analysts that the dollar will soon start weakening. For example Bank Leumi head of markets strategy Kobby Levi says, "The expectation is that the interest rate in the US will stop rising this year, and investors think that it might even drop as early as 2023 to a certain level. There is a gap between what the Fed expects and what the market expects, and this is fertile ground for uncertainty and volatility in the process of bridging these gaps, a process that could happen in the first or second quarter. In this situation, other currencies in which the tightening process started later, such as the euro and sterling, will receive a tailwind and in the relatively low liquidity environment of December, these trends were intensified"
But Levi warns that it may be too early to make assumptions about the dollar. "If we look at the dollar against specific currencies, the forecasts of the last few weeks show that it is possible that the strengthening of the euro and the sterling against the dollar was a bit exaggerated. The expectation from those forecasts is that only at the end of 2023 we will reach the levels we have reached today, and these expectations are supported by the macroeconomic angle according to which Europe has a very challenging economic environment that some economists already claim is in recession and some estimate that the recession will come in the very short term."
Levi believes that the dollar might not become as strong as it was again, but it may be that the sharp devaluation it experienced over the last month was a little premature in relation to the current macroeconomic conditions, and we will see a correction in the near future. "Ahead of next year, each case needs to be examined individually and there are currencies like the Japanese yen where there was a trend change, with the yen being the currency that strengthened the most against the dollar recently." Regarding the shekel, which behaved in the opposite way to other currencies against the dollar during December by weakening, it was of course also devalued against other currencies like the euro and sterling, reaching levels not seen for a long time, even though for most of 2022 the shekel had been realtively stable and maintained its value.
Levi says, "What affects the shekel in the short term is mainly the global stock markets, which have fallen over the past few weeks, mainly following interest rate decisions and expectations that the monetary environment will remain tight for a longer time,"
Levi is referring to the fact that Israeli institutional investors, most of whose investments are already made abroad and are made in dollars, hedge their investments, so when the stock markets fall, they buy dollars to maintain their value, contributing to the shekel's depreciation.
Bank Hapoalim chief strategist Modi Shafrir dismisses the idea that the recent weakening of the shekel might be due to investors' concerns about the policies of the new government. "Contrary to the sharp drop (in a global comparison) in the shekel exchange rate and the local stock market, other markets do not indicate a deterioration in economic sentiment towards Israel - for example, the steepness of the government bond curve in Israel (10-30 years) has dropped sharply since the election results, and the additional yield required for dollar bonds that the State of Israel issued abroad decreased over the last month compared with the corresponding US bond."
In terms of inflation, the weakening of the shekel will have negative repercussions. Levi says, "Appreciation of the shekel is a factor that suppresses inflation, and the devaluation of the shekel encourages inflation. Meanwhile, the shekel's devaluation is very limited against the basket of currencies, and so the inflationary pressures created are limited. If the shekel strengthens again, it is safe to assume that this will suppress inflation. The devaluation is included in the Bank of Israel's calculations ahead of the anticipated interest rate hike on Monday, but the change in the exchange rate is neither surprising nor dramatic enough to change macroeconomic decisions that arise from the inflation picture. The devaluation may have boosted inflation to some extent, but it was certainly not the main cause of it, and there are more significant factors supporting the increase in the inflation environment that the Bank of Israel is relating to, like the labor market, the macroeconomic situation, global trends etc."
The forecast: The shekel will strengthen later this year
Israel's investment houses tend to believe that the shekel will strengthen gradually against the dollar perhaps even to around NIS 3.37/$ on average. The heart of the consensus is NIS 3.40-3.45/$ and Bank Leumi believes that the shekel will range between NIS 3.40-3.50/$ during 2023.
Levi says, "In 2023, the basic forces of a current account surplus and capital moving into Israel are expected to continue and support the appreciation of the shekel. On the other hand, the declines in stocks, which were the main force weighing on the shekel in 2022, are expected to continue temporarily. In this, you have to take into account the Bank of Israel, which can manage the market with a lot of flexibility and instruments it has in its tool box. It can lower or raise the shekel rate with the tools it has."
Israel Discount Bank's economists also feel that the negative correlation of the dollar with the stock market has strengthened, and it functions as a hedging device against declines on stock markets. Thus, the continued uncertainty due to global recession concerns and volatility in the world's stock markets in the first half of 2023 will affect the dollar exchange rate in their estimation, with declines in the capital markets supporting the strengthening of the dollar in the world, and vice versa.
Shafrir also refers to political effects on the shekel. He says, "On the one hand, continued structural forces support a strong shekel in the long term, on the other hand, the behavior of the markets will have an effect mainly in the short term. Regarding government's policy - if its measures lead to a substantial departure of foreign investors from Israel, this will lead to a weakening of the shekel. But in a scenario where Netanyahu moves forward on peace with Saudi Arabia (according to political reporters, the issue is a very high priority) - this will strengthen the structural factors that support a strong shekel."
Published by Globes, Israel business news - en.globes.co.il - on January 2, 2023.
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