The growing fear of escalation of the confrontation between Israel and Hezbollah in Lebanon has raised the pressure on Israel government bonds. Yields to redemption on long-term government bonds have shot up in the past few days, reflecting the increased risk that investors attribute to the State of Israel’s debt.
The yield to redemption on shekel-denominated 10-year government bonds is currently 5.2%, the highest for thirteen years, and representing a rise of more than 0.5% within two weeks. A year ago, the yield to redemption on the same bonds was 3.8%. The yield on 30-year shekel-denominated government bonds is currently 5.7%, which compares with 4.1% a year ago.
The rise in the yields on government bonds derives of course from the decline in the bonds’ prices. Prices of ten-year shekel bonds have fallen by 4.8% so far this year, while prices of 30-year shekel bonds have fallen by 13%. These declines are partly caused by the substantial increase in the rate at which the Israeli government is raising debt to meet the costs of the war. In July, for example, the government will raise NIS 17.5 billion, double the amount in the months preceding the war.
The significance of the rise in yields is that the government will have to pay higher interest rates to investors in new bond offerings. This is also due to the fall in Israel’s credit rating. In April this year, S&P cut Israel’s sovereign rating from AA- to A+. In practice, dollar-denominated Israel government bonds are priced in line with a much lower rating, somewhere between BBB- and BB+.
A further explanation of the decline in the price of Israel government bonds is the sell-off by foreign investors since the start of the war. Modi Shafrir, chief financial markets strategist at Bank Hapoalim, points out that, since September 2023, these investors have reduced their holdings of Israel government debt by NIS 23.5 billion, representing 5% of their total holdings.
The yield on 10-year US Treasury bonds, considered the benchmark, currently stands at 4.46%, after rising from 4.2% within the past two weeks.
Another figures that indicates the rise in the risk attributed to Israel government debt is Israel’s risk premium as embodied by the 10-year CDS (credit default swap), a kind of insurance policy against default by the borrower. The CDS price is currently 176 basis points, an eleven-year peak, reflecting foreign investors’ fear of a serious conflagration on the northern border.
In the past few weeks, more and more countries have warned their citizens in Lebanon that they should leave the country. The CDS price on Israel government bonds has risen constantly in the past few months, and it is now higher than it was when the war broke out in October 2023, about 160 basis points. Before the outbreak of war, it was at about 80 basis points.
Amir Kahanovich, deputy CEO and chief economist at Profit Financial Services, says that the international measures such as the CDS and Israel government debt raised overseas indicate that "Israel’s risk premium has jumped." "These are not healthy price levels, but were in a war," he says.
"The Italian government’s risk premium during the Covid pandemic shot up to 225 basis points," Kahanovich reminds us. "When the pandemic ended, the premium fell back to around 70 basis points. So the rise in the risk premium is not because of the government’s day-to-day conduct. In war, there’s uncertainty, and we are threatened by missiles. The CDS rose more because of the security risk than because of the country’s financial conduct."
When it comes to the yield levels on shekel bonds, Kahanovich is less concerned. "The yield on Israel government bonds does not really reflect risk. You can look at Australia, which has a very low CDS price of 11 basis points. That may be the lowest in the world. Australian dollar-denominated ten-year government bonds are traded at a yield to maturity of nearly 5%. In my view, the high yields on shekel government bonds are mainly connected to investors’ expectations about inflation."
In late 2021, before interest rates started to rise, anyone who bought a ten-year Israel government bond received an annual return of less than 1%. Today, when the yield is more than 5%, does such a bond represent an investment opportunity?
"No-one has a crystal ball," Kahanovich says. "We live in a world in which we mainly manage risk. If every time that an event like this happened people were to buy bonds, over time they would make an above-average return. But it should be stressed that investments need to be diversified."
Published by Globes, Israel business news - en.globes.co.il - on July 3, 2024.
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