Israel's risk premium rises after rejection of Herzog's plan

President Isaac Herzog credit: Mark Neiman GPO
President Isaac Herzog credit: Mark Neiman GPO

Analysts find that while the risk premium is far from panic levels, the markets are signaling a belief that the chances of compromise on judicial reform have receded.

The capital and foreign exchange markets continue to price the effects of the government’s judicial overhaul and signal an adverse effect on Israel’s risk premium and the international value of the shekel.

Meitav Dash chief economist Alex Zabezhinsky explains that the behavior of the markets, as expressed in the depreciation of the shekel and the rise in Israel’s risk premium, that is, the extra interest rate that investors demand in order to invest in the country, indicate a belief that the chances of a compromise on the government’s planned changes to the judicial system have weakened, increasing the risk to economic growth. He adds that Israel’s risk premium has risen sharply in the past week by ten basis points to 87.

"It appears that in the past few days several deals were done at a higher premium that was given to Israel a week ago, meaning another jump in Israel’s risk premium. This links to the economic logic according to which Israel is now at higher risk and it is certainly a signal that the markets are sending, against a background of warnings from the rating agencies and of various economists," Zabezhinsky says.

Israel’s risk premium is now on a part with that of countries like Kuwait, Abu Dhabi, and Qatar, and higher than that of Spain and Portugal. A year ago, Israel’s economy was considered to be less at risk than that of Spain.

A senior analyst told "Globes" that the pictures, newspaper articles and information coming out of Israel concerning the changes in the legal system and the protests against them were unsettling for investors. "If I were a global investor not thoroughly familiar with the material and I saw the questions being raised about the democratic character of a country defined as a democracy, it would worry me too."

Even so, both this analyst and Zabezhinsky point out that this is still not a case of massive pressure from investors. "It’s true that the risk premium has opened up, but it Is not at levels that broadcast panic by the markets, so we are still not in some dramatic event," the analyst says, while Zabezhinsky points out that Israel is one of a group of countries with risk premiums that are not very low, but that are still considered reasonable.

Zabezhinsky also mentions that the rise in the risk premium goes along with weakness of the shekel versus the US dollar and with an underperforming Israeli stock market versus the markets in the US and Europe.

Shekel weakens despite rise in US stocks

As far as the shekel-dollar exchange rate is concerned, historically there has been a close correlation between that and the US stock market, particularly the Nasdaq index. When US stock markets fall, the shekel weakens against the dollar, a phenomenon caused by the fact that hedging activity by Israeli financial institutions with holdings in US stocks is a dominant factor in the foreign exchange market. In the past few weeks, that correlation has several times been broken, with the shekel weakening against the dollar even when US stock markets have risen.

According to Zabezhinsky, although there has been a cumulative decline in the US stock markets so far this month, it can clearly be seen that the depreciation of the shekel is greater than would normally follow from that decline.

Leader Capital Markets chief strategist Jonathan Katz, commenting on trends in the exchange rate in his weekly market review, writes, "Without a reasonable compromise on the ‘legal reform’, there is certainly a substantial threat that depreciation pressure on the shekel will continue." Katz adds that this could affect the Bank of Israel’s next interest rate decision in two weeks’ time. This is in the light of the fact that the Consumer Price Index reading for February was higher than forecast, and inflation continues to be "sticky" and "broad", which Katz says is a worrying development as far as the Bank of Israel is concerned.

"At this stage, it looks as though the Bank of Israel will raise its interest rate by 0.5% on April 3 regardless of the US Federal Reserve’s interest rate decision. The Bank of Israel is charged with attaining the inflation target, and for the time being the inflation environment in Israel shows no sign of calming down, with the depreciation of the shekel expected to contribute more to inflation in the coming months. In its last interest rate announcement, the Bank of Israel cited the depreciation of the currency as a factor in its decision to raise the rate by 0.5% and not 0.25%," Katz writes.

"Uncertainty for households"

Zabezhinsky says that the rise in Israel’s risk premium and the depreciation of the shekel are "a further indication of a rise in the risk associated with Israel," and this at a time when the economy is already slowing, with the slowdown expected to worsen in the coming months according to Meitav Dash.

"Beyond the effect of the rapid rise in interest rates and the weakness of the technology sector, which is important in the Israeli economy, the level of uncertainty is expected to rise and sentiment will be harmed," Zabezhinsky says, referring to the Central Bureau of Statistics’ consumer confidence survey. The survey found that in the current environment, both businesses and households will avoid making significant economic decisions, which will impair growth.

"If households feel unsure about what will happen in a year’s time and choose to postpone decisions because of the situation in the country and not make large purchases, that ultimately affects economic activity," he says.

Published by Globes, Israel business news - - on March 20, 2023.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2023.

President Isaac Herzog credit: Mark Neiman GPO
President Isaac Herzog credit: Mark Neiman GPO
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