iran missile shihab
An Iranian Shihab missile. Photo by AP
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The price of CDSs for five-year government bonds. Photo by Haaretz

The cost of insuring Israeli government bonds against default - credit default swaps, better known by their initials, CDS - has soared 22% in the past week as the markets grow increasingly nervous about veiled Israeli threats to attack Iran.

The price of a CDS contract on five-year government bonds rose from a level of 140 basis points on August 10 to 170 points at the end of last week, meaning bond buyers are now paying a premium of 1.7% for insurance. Nevertheless, the cost of insurance is less than it was at the start of the year when it was about 190 points.

A CDS agreement is one where the seller is obligated to compensate the buyer in the event a bond defaults. A military strike on Iran is likely to cost the Israeli economy tens of billions of shekels in damage, lost output and government spending from a retaliatory attack by Iran and its allies.

Government officials are weighing how much extra an attack might cost in terms of boycotts of Israeli exports, or whether it might cause some countries to bar exports of military equipment to Israel. One of the economy's strongest defenses is the $75 billion in foreign reserves at the Bank of Israel, which could cover 10 months of import costs.

Of immediate concern to bond investors is that an attack would lead to a drop in Israel's sovereign credit rating.

Successive prime ministers and finance ministers have viewed Israel's credit rating, which is awarded by international agencies like Standard & Poor's, Moody's and Fitch, as a seal of approval for their sound management of the economy. They have taken measures, such as the current round of budget cuts and tax hikes, with an eye to ensuring that the rating isn't downgraded. A lower credit rating would mean higher borrowing costs both for the government and private sector businesses, whose credit profiles are closely linked to the country's, adding to the cost of an Iranian attack.

Yesterday, Israeli government bonds rose, snapping a week of sharp declines. Ten-year shekel bonds gained 0.15%, pushing their yields down to 4.27%. Nevertheless, it remains a dramatic rise in yields for official debt: Weeks earlier the yield on the bonds had fallen to a record low of 3.86% on the back of strong domestic demand.

Options of the U.S. dollar traded yesterday at NIS 4.03, a slight rose compared with the Friday representative rate for the greenback of 4.028.

"As long as chatter about attacking Iran grows, together with the decelerating of the economy, the local currency will grow increasingly weaker," said Eitan Madmoni, head of financial markets at Bank of Jerusalem.