In the first half of 2022, the shekel was one of the world's weakest currencies, depreciating against 20 out of the 23 major currencies. But in July, the situation changed and the Israeli currency strengthened against all 23 of the world's major currencies. In overall perspective, since the start of 2022, the shekel has strengthened against 11 currencies and weakened against 12.
Two main factors have influenced the shekel-dollar exchange rate. Trends on world stock markets (falling sharply and then rising in July) and the movement of the dollar on world markets. The main reason for the strong reverse relationship between the shekel-dollar exchange rate and the trend in global stocks stems from the activities of Israeli institutional investors. When the stock exchange is falling, their exposure to foreign currency falls and they buy foreign currency to restore increased target exposure.
A more immediate connection stems from the need for institutional investors to increase collateral in foreign exchange on holdings in stock contracts abroad in cases of declines, especially sharp declines. In the first half of 2022, the MSCI All World index fell 20.9%, the steepest decline since the index was launched in its current format in 1988. Over the same period, the shekel weakened by 12.6% against the dollar, the sharpest fall over these years.
However, the depreciation of the shekel against the dollar was still abnormal in relation to the trend line resulting from the decline in stocks. In other words, while the weakening of the shekel was logical, the strength of the depreciation in the first half of 2022 was exaggerated.
Growth in Israel's tech exports and current account moderated
Recently, a slowdown in the growth rate of Israel's tech services exports (excluding exits) has been evident. Between March and May 2022, therer was a year-on-year rise of 14.4% (the average for the three months), the most modest rate since June-August 2020.
At the macroeconomic level, in the first quarter of 2022 there was a sharp fall in the current account (without deductions for seasonal factors) to about $4.5 billion, from the relative peak of $8.5 billion in the fourth quarter of 2021.
In an annual perspective, it seems like a current account surplus of 3%-3.5% will be recorded for 2022. This is a positive figure, but more moderate than last year's surplus and also slightly lower than the average surplus between 2016 and 2019 (about 3.5% of GDP).
The shekel will appreciate against the dollar in the long term
Looking one year ahead, we believe that the shekel will strengthen significantly against the dollar, and perhaps even over the shorter term. According to several models and different analyses, we see the shekel-dollar exchange rate trading at NIS 3.25-3.27/$ in another year, with a high likelihood that it will be much lower than this range.
One of the reasons for this is that the expected rise on stock markets will be translated into the strengthening of the shekel. Looking one year ahead, we estimate that there is a high chance the global stock market index will be up 10% or even more than its current level. This is also mainly because of the forecast that while the US Federal Reserve will raise the interest rate more sharply than markets have priced in for the short term, looking one year ahead the rise in interest rates would have ended or will be nearly complete. The stock exchanges have already, 'looked and priced in the situation ahead.'
Another reason for the future strengthening of the shekel, is the forecast that the US dollar will weaken against the euro and other western currencies - a situation that will support the depreciation of the dollar against the shekel. The shekel is being traded at a level that is 'too weak' in a range of parameters such as the purchasing power parity (PPP) of each currency. This is an exceptional situation in relation to recent years, when the shekel has for the most part been traded above the value derived from PPP.
So it seems that the weakness of the shekel in the first of half of 2022 was also exaggerated regarding the overall trend of weakness in stock exchanges. In general terms, despite the expected moderation in the current account surplus this year - it is still a positive surplus, and the structural factors will continue to support a stronger shekel against the dollar.
The author is market strategist in Israel Discount Bank's Trading Room. The survey is for general information and should not be seen as a recommendation or advice regarding currency investment.
Published by Globes, Israel business news - en.globes.co.il - on August 10 2022.
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