The Israeli shekel has gained 12% against the US dollar over the past five years. No other currency in the world strengthened against the dollar during this period. The Israeli currency did not make a major jump in any one year, but it was among the leaders in every one of the past few years.
This unusual result can be attributed to the strength of the Israeli economy or the Israeli startups snatched up by foreign companies, but the truth is that no explanation can justify such a wide gap between the shekel and the rest of the world. There are other countries that have been on the receiving end of direct investments, and have even received larger investments than Israel in relation to the size of their economies. There are other countries with a current accounts surplus even larger than Israel's in terms of GDP. If we add to this the fact that the Bank of Israel bought $33 billion, the results obtained appear even more disturbing.
It appears that the shekel has strengthened too much, beyond economic equilibrium. It is not yet on the scale of bitcoin, but it is in the same direction. The lack of maneuvering room by the Bank of Israel, which cut the interest rate too fast, and has been left with no tools, thereby aggravating aggressive speculative activity in the Israeli currency, may have contributed to this. Another factor is the herd of investors blindly stampeding in one direction, while mindlessly repeating that the shekel can only get stronger.
2018 might be the year in which the shekel changes direction. There are a number of reasons for this.
First of all, the growth rate of the Israeli economy has stood out in recent years. While many countries were dealing with the consequences of the crisis, Israel, which was affected only indirectly, was an exemplar. As former Governor of the Bank of Israel Stanley Fischer said, no strong economy has a weak currency. This situation, however, is starting to change. The Israeli economy was one of the few in which the growth rate fell this year. Private consumption grew at a slower pace. The real estate market has come to a halt. Arrears are starting to appear in mortgage payments, bank loans, and credit card companies, following a substantial rise in consumer credit and housing loans in recent years. Exports of goods are also starting to falter because of the strong shekel. Fewer exports mean fewer dollars in the economy. That does not mean that the economy is entering a recession, but the slowing of growth this year is projected to get worse next year. Following Stanley Fischer's saying, when the economy weakens, the currency can also weaken.
Another reason why the shekel is likely to weaken results from the movement begun by central banks around the world. The US Federal Reserve is likely to raise the interest rate, thereby opening a 2% gap between its interest rate and that of the Bank of Israel by the end of 2018. The interest rate in the UK and Canada has risen above the floor. If the improvement in the global economy persists, more banks will join this trend. On the other hand, no interest rate hike by the Bank of Israel is in sight. Interest rate gaps do not always influence the currency immediately, but that does not mean that the shekel will not weaken later.
Finally, investment institutions customarily hedge part of the risk relating to the strengthening of the shekel through overseas investments. The hedge neutralizes the effect of their buying dollars for these investments and reduces the pressure on the shekel. As the interest rate gap between the US and Israel widens, however, the hedge becomes more costly, until it makes the investment unattractive. It is difficult to justify buying US bonds with a 3% yield when 2% of it must be used for protection against a shekel appreciation.
The net amount of money entering financial institutions, provident fund, and insurance companies is expected to reach NIS 60 billion this year, double the amount in 2013. The Israeli market is too small for such amounts. The investment institutions have no alternative to overseas investments. Because of the rising cost of hedges on the one hand and the need to invest overseas on the other, we can expect financial institutions to hedge less. In this event, the effect of their buying dollars is likely to weaken the shekel.
To summarize, the wind is starting to shift. The shekel is likely to lose some of its strength and its leading position, and to revert to behaving like every other currency around the world.
The author is chief economist of Meitav Dash Investments Ltd. (TASE:MTDS). The above should not be regarded as investment advice or marketing, and does not constitute a substitute for investment consultation or marketing that takes into account each person's unique figures and needs.
Published by Globes [online], Israel Business News - www.globes-online.com - on November 27, 2017
© Copyright of Globes Publisher Itonut (1983) Ltd. 2017