Israeli Shekel Weakens Sharply Amid Rising Risk Premium and Global Dollar Strength

The Israeli shekel has sharply weakened over the past month, crossing the 3-shekel-per-dollar threshold after trading below 2.8 shekels in May. This decline makes it one of the weakest currencies among developed markets recently, surpassed only by the Norwegian krone and Russian ruble, both affected by plunging oil prices.

Financial strategist Modi Shapir from Bank Hapoalim attributes the shekel's drop to several factors: a stronger US dollar globally, increased Israeli risk premium following the US-Iran agreement, Bank of Israel's currency interventions, Nasdaq declines, and interest rate differentials between Israel and the US. Institutional investors in Israel have reversed their foreign currency exposure trend after 18 months, potentially amplifying the shekel's depreciation.

The risk premium, measured by the spread between Israeli and US bond yields and CDS contract prices, surged from under 40 basis points in November 2022 to 140-160 basis points after the October 7 war outbreak. Although it dropped to about 49 basis points following the ceasefire agreement, it has since risen again to around 54 basis points, reflecting ongoing geopolitical concerns.

Interest rate differentials also pressure the shekel, with Israeli markets pricing a 2.9% rate in a year while US markets anticipate further hikes despite easing inflation expectations. Bank of Israel intervened by purchasing roughly $800 million in May to stabilize the market and signaled readiness to lower rates if inflation expectations fall near 1%, potentially accelerating rate cuts due to the shekel's recent appreciation.

External factors include significant declines in US tech stocks, which influence Israeli institutional investors' foreign currency exposure. Data shows institutional foreign currency exposure rose to 20.5% in April from 19.1% in March, indicating increased risk perception despite a temporary ceasefire with Iran.

Looking ahead, economists note the shekel remains historically strong despite recent weakness. Bank of America recommends a long position on the dollar against the shekel, targeting 3.14 shekels per dollar within three months but advises exiting if the rate falls below 2.9. While fundamental factors like Israel's export surplus and tech investments support the shekel long-term, the currency's near-term trajectory depends on geopolitical developments and monetary policy adjustments. Strategist Shapir expects a modest rate cut by Bank of Israel in July and warns that sustained shekel weakness could lead to higher inflation over the next six months or more.