Moody's, war, fiscal deficit - the shekel marches on

Shekel strengthens  credit: Knesset Spokesperson's Office, IDF Spokesperson  processing: Tali Bogdanovsky
Shekel strengthens credit: Knesset Spokesperson's Office, IDF Spokesperson processing: Tali Bogdanovsky

The shekel is at a nine-month peak against the US dollar despite a rating downgrade, possible all-out war with Hezbollah, and the war's costs. "Globes" examines why.

Moody’s downgraded Israel’s sovereign credit rating, the fiscal deficit is swelling, and huge uncertainty surrounds events in the Gaza Strip and on Israel’s northern front. None of these factors has prevented the shekel from strengthening to a nine-month peak against the US dollar. The representative exchange rate was set on Friday at NIS 3.565/$, a level not seen since June last year. Last week alone, the shekel strengthened by 2%.

There are various explanations for the strength of the Israeli currency. Some of them are purely economic, and some rest on geo-political forecasts that are generating positive sentiment. At any rate, the stronger shekel is good news for Israeli consumers, and for the Bank of Israel, since it helps in keeping Israel’s annual inflation rate within the 1-3% target range.

More buyers than sellers

Despite the war in the Gaza Strip and the open questions about the northern front, long-term factors apparently favor a strong shekel, and there are therefore more buyers than sellers. One of them is the positive balance of payments. The balance of payments reflects the economic transactions between the Israeli economy and other economies in a given period, including deals in goods, services, income, financial transactions, and so on. According to the Central Bureau of Statistics the current account surplus in the third quarter of 2023 (before the war) was $5.8 billion, up from $4.5 billion in the previous quarter.

Another important factor is the activity of financial institutions, of which more later. According to statements by several investment managers at Israel’s financial institutions, they see the Israeli capital market as attractively priced in comparison with other world markets, and are raising their exposure to it.

Nevertheless, a market source told "Globes", "The brand ‘Israel’ has taken a severe blow in the past year because of internal strife and because of the war. Investors around the world look at us differently, and prefer to put their money in countries that are more stable, both internally and geo-politically."

A gift from America - unstoppable markets

The financial institutions have a huge impact on the Israeli foreign exchange market. Every movement of money by them into or out of Israel affects the exchange rate immediately. Every transfer they make is of a huge amount, in the billions. Besides the decision on increasing their exposure to Israel, there is something else that leads the institutions to buy or sell dollars, namely fluctuations on Wall Street. Apart from a few months last year, because of the crisis over the judicial overhaul promoted by the Israeli government, we have become accustomed to the formula that when stocks rise in New York, the shekel strengthens against the dollar, and conversely, when stocks in New York fall, the shekel weakens.

Since the beginning of this year, the momentum on Wall Street has been very positive. The Nasdaq index has risen 10%, and the S&P 500 has risen 8%. In such a situation, with the value of their dollar assets rising, the institutions sell dollars in order to restore the balance between dollars and shekels in their portfolios. In addition, the US dollar is considered a safe asset and a refuge when stock markets are falling. When the trend is so positive, more investors abandon the dollar and put their money in stocks.

Deficit and rating downgrade priced in

Two factors that on the face of it ought to weigh on the shekel are the large fiscal deficit expected this year - 6.6% of GDP - and the decision by Moody’s to downgrade Israel’s sovereign rating to A2. Both these factors, however, are priced in to the current exchange rate. Israeli bonds are traded on world markets at levels of countries rated BBB+. As for the deficit, as long as it is seen as temporary, investors aren’t concerned about it.

Even if the other international rating agencies, S&P and Fitch, follow Moody’s and cut their ratings for Israel, that is not expected to cause any significant movement in the shekel-dollar exchange rate, assuming that other economic parameters remain the same.

The stance of the Bank of Israel is also tending to strengthen the shekel. At the beginning of the war, when the shekel depreciated sharply and the rate against the dollar reached NIS 4.1, the Bank of Israel expressed determination to strengthen the currency, and launched a $30 billion support program. In practice, it used only $8.5 billion, but the very fact that the market is aware of the Bank of Israel in the background ready to intervene contributes to the shekel’s appreciation. The fact that the central bank held its interest rate steady in its most recent decision as did not lower it has also tended to strengthen the shekel, as certain investors who thought that there would be an interest rate cut closed their positions and sold dollars.

The development not priced in

The scenario that the foreign exchange and stock markets are not currently pricing in is a negative development on the northern front leading to all-out war with Hezbollah. The situation is currently viewed as a limited confrontation that will not worsen. A market player told "Globes" that he thought that if Hezbollah fired a missile at central Israel, we would see the shekel-dollar rate jump immediately by NIS 0.20. A broader event in the north will of course lead to deterioration in Israel’s other macro metrics, and will entail further growth in government debt and a higher debt:GDP ratio. As mentioned, however, the market is not currently pricing in such a scenario, and reflects the view that we are not on the way to it.

Another factor contributing to optimism is the many assessments that we are on the way to a ceasefire in the south, which will inject some certainty into the markets, at least for a while.

A weight off the market’s shoulders?

Before the war, Israel experienced an internal storm over the far-reaching changes that the government sought to introduce into the country’s legal system. That had considerable consequences for the economy, seen in the diversion of investments to other countries and a sharp rise in the shekel-dollar exchange rate. The Bank of Israel estimated at the time that the shekel was subject to a negative premium of 15%.

The general view on the market is that that event is over. At least as far as foreign investors are concerned, it would appear that a legal reform or revolution that will again weigh on the economy and deter investors is not on the horizon. One market player went to far as to say that foreign investors were pricing in the possibility of an election and the advent of a centrist government.

The bottom line is that the shekel, which had been one of the strongest currencies in the world against the US dollar in recent years, lost its strength last year because of extreme events - an unprecedented internal struggle, and an unforeseen war. It’s hard to give a clear-cut answer to the question whether the current positive trend will continue, and there are many variables that will determine what the picture will look like.

Published by Globes, Israel business news - - on March 4, 2024.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2024.

Shekel strengthens  credit: Knesset Spokesperson's Office, IDF Spokesperson  processing: Tali Bogdanovsky
Shekel strengthens credit: Knesset Spokesperson's Office, IDF Spokesperson processing: Tali Bogdanovsky
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