It has become routine to watch the shekel-dollar exchange rate depreciate above new thresholds on a daily basis. Last week the rate weakened from NIS 3.80 to NIS 3.85/$ at one point on Thursday. The consensus in the market is that the current state of affairs has not yet reached the ceiling. How far can the rate go? This is already a more complex question and the variables that will decide this are many - a combination of financial markets, politics, a lot of psychology and sophisticated players. The factors that support the weakening of the shekel include:
The judicial reform
The upheaval in the foreign exchange market began at the same time as Minister of Justice Yariv Levin's introduced the plan to reform the judicial system. Since then, the entire financial system has been in turmoil and suffering from uncertainty. The Bank of Israel even presented data that demonstrates how specific events surrounding the reform sharply moved the market upward or downward. When there have been indications of a compromise, the shekel has strengthened. When protests escalate and demonstrators take to the streets the shekel weakens.
In general, the market estimates that the risk premium caused by the reform on the shekel-dollar exchange rate has risen. If until recently there was talk of NIS 0.30-40 per dollar, now the estimates are closer to NIS 0.50 for every dollar. When looking at the performance of the dollar in the world against the basket of major currencies, the US dollar has strengthened since the start of 2023 by just over 1% compared with 10% against the shekel. Put simply, without the uncertainty and the backlash the judicial reform has generated, we would probably have seen the dollar trading between NIS 3.35-3.55/$ today - a dramatic difference.
At present, the Knesset is in recess, but the hearings at the High Court over the coming week on petitions to strike down the law on the reasonableness standards and the talk of a compromise, which broke down within a few hours, increase the uncertainty. The biggest fear among investors, especially foreign investors, is a severe constitutional crisis.
A rise in the level of pessimism
If initially, major volatility on the forex market worked in both directions, now it seems that the pendulum has moved mainly in the direction of pessimism. For example, when President Isaac Herzog spoke about nearing a compromise back in March, the shekel strengthened significantly. In June, when talks were still continuing at the President's residence, positive trends were seen in terms of the shekel. Even a recent report in "The Wall Street Journal" about progress in talks between the US and Saudi Arabia on normalization with Israel saw the shekel jump briefly.
In the last few weeks, this has happened less. A series of supposedly positive events from the state's point of view did not convince investors to buy the Israeli currency. For example, rating agency Fitch published an overall positive report on Israel on August 14, and reaffirmed the country's credit rating and outlook, but the shekel-dollar exchange rate remained unchanged. The following day there was even a slight weakening of the shekel.
Even developments such as the announcement of the biggest arms deal in the country's history, the sale of the Arrow 3 defense missile system to Germany, or the announcement by the ultra-Orthodox parties that they will not support further judicial reform legislation until the conscription law is passed, did not convince investors that matters are behind us. Bottom line, the market has recently had a lot more people selling shekels than buying them.
Sophisticated players operate in the foreign exchange market, and psychology remains a major factor. About three weeks ago, forex traders with whom we spoke still wondered how long it would take for the shekel-dollar rate to cross the NIS 3.75/$ resistance point. As soon as it happened, the market wondered what the next resistance point would be.
One trader said, "The foreign exchange market is a speculative market and reflects the management of expectations. Psychology is a major factor here." Thus, every break above a threshold actually fuels the continued depreciation of the shekel. Since August 15, the representative shekel-dollar rate has not once closed below NIS 3.75/$. On the other hand, having moved above NIS 3.80/$ last week, will it fall back below? We will probably get the answer in the coming days.
A market trader explained that the next resistance point will be NIS 3.88 - a level that was recorded for only one day at the start of the Covid pandemic and prompted the intervention of the Bank of Israel. Another claims that round numbers have a psychological meaning for investors. It can be 3.85, 3.9 or even NIS 4/$.
The impact of Wall Street
One of the points that played in favor of the shekel, despite this year's depreciation of the shekel, has been Wall Street. From the start of 2020 until the end of July, there was an impressive rally, which saw the S&P 500 index climb 20% and the Nasdaq index almost 40%. This has a positive effect on the shekel because of Israel's institutional investors.
Prior to the judicial reform crisis, the rule of thumb regarding institutional investors was relatively simple. If Wall Street rises, sell dollars and buy shekels and reduce exposure to foreign exchange and vice-versa. The institutions deal in very large amounts, billions, and thus their activities move the shekel-dollar exchange rate. In addition to the fact that the institutions have increased their exposure to foreign exchange this year due to the crisis, the trend on Wall Street has reversed since August. Government bond yields are climbing and stocks are falling, and thus institutions have to sell more shekels to maintain the same exposure to foreign exchange.
The dollar is also considered a safe haven asset during market downturns. The currency is currently strengthening globally and is now at a six-month high against the entire basket of currencies, and the shekel is paying a price for that as well.
Simply put, even if nothing new happens and uncertainty remains as it is, the declines on Wall Street alone could lead to a strengthening of the dollar against the shekel. If the negative trend on Wall Street continues, the dollar is expected to continue strengthening.
Another factor that works to the detriment of the shekel is the increase in the number of savers who prefer routes with increased overseas exposure, mainly tracking the S&P 500 index. As of the end of July, NIS 21.5 billion was managed in pension plans that track the index, which is 3.1% of the assets of the new pension funds, almost double the amount in such investments in January 2022. This is a kind of vicious circle, so that as the shekel weakens against the dollar, the temptation to invest the savings abroad increases. Even if a very small percentage of the millions of employees in Israel do so, this is another negative pressure on the local currency.
The buyers and the sellers
Not only the Israeli institutional investors increased their foreign exchange exposure. Speculators and foreign institutions also play a central role in what is happening. For example, US investment bank Citi reported this week that it shorted the shekel and recorded a handsome profit.
Citi is not alone. Several foreign banks have issued investment recommendations and forecasts regarding the shekel in recent days and they are not particularly optimistic. Deutsche Bank published a document under the title "The shekel - cheap but not encouraging," in which they assessed that "in the short and medium term there are significant factors that will continue to weigh on the Israeli currency." The bank's economists mentioned, among other things, the dramatic hearing that will take place at the High Court on Tuesday on petitions against the law on reasonableness standards, and the fear of the situation deteriorating into a constitutional crisis in the most pessimistic scenario.
JP Morgan's analysts have also published a pessimistic forecast for Israel's currency. "Continuing domestic political risks have led to a change in the structure of local institutional investments, who have increased exposure to assets abroad," the analysts wrote, mentioning the uncoupling between the behavior of the shekel and Wall Street performance. JP Morgan added, "It is reasonable to assume that the political risk will remain high." The investment bank added that it remains bearish on the shekel.
The decline in investments in Israel is making its mark
The sharp decline in investments in Israel is also making its mark, especially in the tech sector. Last week the Ministry of Finance reported a drop of about 60% in total foreign investments in Israel in the first quarter of 2023. Although the defense industries are booming and bringing quite a few dollars into Israel, this still does not offset the shortfall. The market also feels that the uncertainty surrounding the future of Bank of Israel Governor Prof. Amir Yaron is bothering investors and contributing to the depreciation of the shekel.
And where is the Bank of Israel, which holds foreign exchange reserves of nearly $203 billion? It is not intervening for the time being. The Governor himself clarified last week, "Despite the great volatility in the foreign exchange market, the market is working and our approach is to let the market find pricing given the uncertainty and risks that have been added to the economy. If we see market failures or extreme conduct, we have the tools to deal with it."
Published by Globes, Israel business news - en.globes.co.il - on September 10, 2023.
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