The shekel is trading against the U.S. dollar at its strongest in 12 years. Should Israelis be worried? Should the Bank of Israel step in and try to reverse the trend?
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The dollar representative rate was set on Wednesday at 3.256 shekels, strengthening 0.25% after the Bank of Israel intervened. Since the start of the year, the dollar has shed about 5.5% of its value against the Israeli currency; since March, when the shekel briefly weakened at the onset of the coronavirus crisis to 3.9 to the dollar, the greenback’s losses have come to 15%.
But the shekel’s strength should be kept in perspective, said Shmuel Katzavian, market strategist for Israel Discount Bank.
“Last year the shekel strengthened against almost all world currencies, while this year it has strengthened against just six, including the dollar. But it has weakened against four currencies, among them the euro. So, despite the sharp appreciation, the shekel’s gains in 2020 have been relatively moderate, compared with the 8% last year,” he said.
“While the shekel may be at a high, we don’t know what the exchange rate should be. There’s no model for estimating its value. There are forces that right now are positive for the shekel, among them the thriving high-tech sector, Israeli interest rates and the current account surplus,” Katzavian said.
Amir Kahanovich, chief economist at Excellence Nessuah Investment House, said Israelis should sit back and enjoy the strong shekel. “A lot of people in Israel hold that a strong shekel isn’t good, but when the shekel is strong the public grows richer. Gross domestic product per capita is higher in global terms,” he explained.
“The case against a strong shekel is that it hurts the old-line industries, which struggle to compete with much lower-wage countries. That will lead to unemployment. However, the weighting of these industries in the economy has shrunk a lot, so despite the shekel’s strengthening, we haven’t seen economic damage. The Israeli consumer is benefitting.”
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High-tech, by contrast, is larger insulated from exchange rate issues, he said. “Demand for high-tech services is more important than the shekel-dollar rate. While service exports get fewer shekels, global demand is the dominant factor.”
Several factors have converged – some of them global, some of them local – to account for the shekel’s strength.
Bullishness hurts dollar
Strangely enough, the feeling that the world economy has put the worst of the coronavirus’ economic devastation behind it has weakened the dollar not only against the shekel but globally. “There’s a sense that the world economy is improving, so investors are looking less for safe harbors and that makes the dollar less interesting,” said Rafi Gozlan, chief economist for the investment house IBI.
Citibank recently predicted the dollar could weaken another 20% in 2021 if the recently unveiled COVID-19 vaccines are utilized widely throughout the world and global trade recovers.
The United States itself has been contributing to the dollar’s weakness, mainly because it has taken to printing money and allowing the federal deficit to grow enormously. The Bloomberg Dollar Spot index shows the greenback has lost 11% of its value since March and many economists say it will lose more going forward.
Factors more particular to Israel have also shaped the shekel-dollar exchange rate.
One of those is the activities of local institutional investors, said Katzavian.
“There’s a strong connection between the global stock markets and the value of the dollar against other Western currencies – the stock market rises and the dollar’s value against local currencies falls. This is a phenomenon that occurs here more than elsewhere in the world,” he said.
With Wall Street trading at record highs, the value of Israeli institutions’ foreign currency holdings reached a record of between 17.4% and 17.7% in August-October, or between $9.9 billion and $13 billion in dollar terms, according to Katzavian. As a result, institutions have been offloading dollars to reduce their exposure, he contended.
A stronger euro has also contributed to the dollar’s weakness. The reason is a landmark 750 billion euro ($908 billion) stimulus spending package approved by the European Union in September to help member economies contend with the effects of the coronavirus.
“At the peak of the [coronavirus] crisis, many doubted Europe’s fiscal unity would survive, that member countries wouldn’t reach into their pockets to help the others,” explained Excellence’s Kahanovich. “But the minute the EU announced a joint fiscal program in September, we saw the euro strengthen. Investors felt more comfortable moving from the dollar into the euro.”
Meanwhile, the growth of Israeli service exports has increased the flow of dollars into the economy, said Katzavian. Israel’s current account surplus grew to close to $4.4 billion in the second quarter and will probably reach $4.9 billion in the third.
“We’re one of the only countries in the world with a current account surplus in the last two year and forecasts are for it to rise further. In the post-coronavirus world, the demand in sectors such as cybersecurity, telecoms, remote work, remote medicine and gaming will be growing, and Israel is relatively strong in these areas and exports quite a bit,” Katzavian explained.
One reason for the growing surplus is coronavirus restrictions on travel. Israelis travelling abroad are deemed service imports while foreign tourists visiting Israel are treated as service exports. Now that tourism traffic in both directions has ground to a virtual halt, Israel is a net gainer because Israeli vacationers log far more trips abroad than foreigners do to Israel.
“Just the stop to tourism contributed a net $300 million increase to the current account in the second quarter,” said Katzavian.
Developments in the world economy are likely to reinforce the factors that have generated current account surpluses for Israel. “Before the coronavirus, the world was undergoing a transition from an economy of goods to an economy of services – a trend that Israel has benefitted from. The peace agreements with the Gulf countries is increasing our export potential,” he added.
The consensus is that despite recent intervention by the Bank of Israel, the central bank will not be able to counter such big market and macroeconomic forces and won’t seriously try.
The last time the shekel was trading at levels like these against the dollar, during the global financial crisis of 2008, the Bank of Israel launched a policy of intervention in the forex market to put a brake on the strengthening currency.
“Today, the Bank of Israel has changed its behavior and appears more focused on solving the crisis in the real economy,” said IBI’s Gozlan.
He said that as long as the world economic situation appeared to be on the upswing, the dollar would continue to lose. “As long as sentiment remains positive and there are no punctures along the way, the dollar will continue to weaken. However, expectations are high right now and if the [world economic] recovery proves slow, the dollar will correct,” he said.
Continued dollar weakness will force the Bank of Israel and other central banks to act more aggressively to stem their own currencies from strengthening further. On Tuesday night, dealers estimated the Bank of Israel bought $350 million in the forex market, helping to lift the dollar off its lowest since 2008.
“Already in its last interest rate announcement, the Bank of Israel resumed using terminology from which you can conclude that it thinks that we’ve reached levels it feels less comfortable with and signaling to the market that they may intervene,” Gozlan noted.