Deutsche Bank's foreign currency strategy department published an analysis earlier this month which pointed out that the shekel was at an all-time high against the dollar. Shortly afterwards, the shekel moved away from that peak with the unexpected 0.7% fall in the June Consumer Price Index (CPI). However, Deutsche Bank strategist Dr. Kalani Gautam, who carried out the foreign currency analysis, said that this is only a temporary correction. He told "Globes," "The long term-strengthening of the shekel will continue. The shekel is one of the most attractive currencies in the world to invest in today."
Born in Mumbai, India and with a Ph.D. from Oxford, Dr. Gautam joined Deutsche Bank in 2013. He began as a macro-economic researcher and then moved to foreign currency strategy in emerging markets with a focus on Russia, Turkey, South Africa, Central Europe and of course Israel.
Globes: Why are currencies in other emerging markets different from Israel? Why is the shekel stronger?
"It's true that other currencies have strengthened recently like the Russian ruble and the Brazilian real but in contrast to the shekel they began at very low levels. The ruble crashed after oil prices fell and the real following the political crisis in Brazil. The shekel has not fallen in recent years and so its starting point was very close to its fair value and its appreciation has brought it deep into historic over-pricing. The shekel is the third most expensive currency in the world (after the Chinese yuan and the Swiss franc) according to a pricing methodology that combines three evaluation models."
Is this a bubble?
"What interests the central bank is not what the exchange rate is but rather where the exchange stands against fair value, which expresses the financial strength. Israel's economic foundations are most strong, mainly the balance of payments surplus and direct foreign investments but our analysis shows that the shekel has strengthened more than it needed to because above and beyond real activities there are speculative investments. From the point of view of investors, a currency that's trend is clearly to strengthen with low volatility and high liquidity is a very attractive currency for investment and the shekel is undoubtedly one of the most attractive currencies."
Can you assess the volume of the speculative investment in the shekel?
"That's very difficult. But we did an analysis of the speculative investments carried out through Deutsche Bank (Deutsche Bank's market share is estimated at 17% of total shekel-dollar transactions worldwide A.B.). Our examination analyzed the transactions performed over 12 months -some of them 'buy' and some of them 'sell'. We saw that from the beginning of 2017 and 12 months back the level of shekel purchases was the highest over the past five years and we are talking about 'non-commercial' purchases, that is to say speculators and investors such as hedge funds. In the past two or three weeks we have begun to see sales, but the clear trend is still towards buying."
What is the main reason for the trend towards strengthening of the shekel in the past year?
"I think the weakness of the dollar. Investors leaving dollar positions looked for an alternative currency to invest in. The popularity of the shekel stems from its low volatility and not only its trend of strengthening. When other currencies crashed against the dollar, the shekel kept its stability. It is perceived as a sort of safe haven. A relatively stable economy, a relatively stable government - it's an attractive market and safer than Turkey, Brazil or Russia."
"The Bank of Israel estimates and hopes that the tendency to strengthen will halt when central banks in Europe and Japan will begin to move towards reducing their super-expansive monetary policies and raise interest rates.
"I'm not convinced about that. Firstly, we have seen the Fed move to a more hawkish policy and that hasn't influenced the shekel. Secondly, it will take a lot of time until the European and Japanese central banks will begin hawkish policies. The ECB will begin to cut bonds purchases only at the beginning of next year. How much tile will that let the shekel strengthen? The euro has strengthened sharply recently against the dollar and that hasn't weakened the shekel against the euro."
Can measures to restrict the activities of speculators succeed?
"That's not something that central banks have succeeded in doing. Especially with currencies like the shekel that are very liquid. The real is much less liquid and therefore Brazil's central bank has much more ability to control it."
So what can the Bank of Israel do?
"The first line of defense is a more aggressive intervention in the foreign currency market. There are central banks that have gone for negative interest rates but I understand that that isn't a real option for the Bank of Israel. The aim of the central bank is to bring the exchange rate closer to the fair value of the currency. The fair value of the shekel against the dollar is NIS 3.66/$. You have to understand that the main analysis in the actions of speculators is based on the trend. Until today the trend has been very strong and fast and the volatility very low, so speculators have jumped in and made the trend more extreme. But the moment that the trend stops they will leave their positions automatically."
What is happening to inflation in Israel?
"Israel is lagging behind the world in the recovery of inflation and that's also a result of the shekel's strength. We estimate that the Bank of Israel will not begin to put up the interest rate before the third quarter of 2018 (a quarter later than the Bank of Israel's own assessments A.B.), but the main risk is that the interest rate hike will be postponed until much longer than that and that inflation will remain low."
Published by Globes [online], Israel business news - www.globes-online.com - on July 28, 2017
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