Israeli and US Elections Create Uncertainty for Financial Markets

Despite the recent Knesset elections, uncertainty continues to grip the Tel Aviv Stock Exchange due to the lack of a clear political outcome and concerns about forming a government and passing a budget. Investors are also awaiting the US midterm elections, which could shift the balance of power in Congress and impact Wall Street. Ronen Menachem, Chief Markets Economist at Mizrahi Tefahot Bank, believes both events will influence markets in the coming weeks. He anticipates a complex government formation process in Israel, potentially leading to repeat elections within six months. In the US, even a political shift will not see the new Congress convene until January 2027.

A major concern for investors is the state budget. Menachem warns that starting 2027 with a continuing budget, coupled with increased defense spending, could necessitate cuts to economic sectors and tax hikes. The absence of a clear budget framework will also complicate deficit and debt targets, especially ahead of credit rating reviews for Israel. Dror Karni, CEO and Founder of Karni Family Office, suggests the primary risk is not necessarily further stock market declines but rising financing costs. He emphasizes that markets seek decisiveness and governability, not ideological winners. Karni believes the significant risk lies in the bond market and exchange rate, even if stock market volatility subsides.

Karni explains that a weakening shekel could increase import costs and fuel inflationary pressures, limiting the Bank of Israel's ability to lower interest rates. Simultaneously, government borrowing needs and Israel's risk premium may continue to push up long-term bond yields. This means that even if the Bank of Israel cuts interest rates, long-term financing costs for the state and companies might not decrease accordingly. Real estate companies and local businesses reliant on credit could be particularly affected, while tech firms and defense exporters with foreign revenue may show more resilience. Menachem also notes signs of pressure in the local market, with the TA-35 and TA-90 indices falling 2.1% and 1.2% respectively on Friday, while the 10-year government bond yield rose to 4.16%. The shekel's weakening against the dollar could also complicate the Bank of Israel's position.

In the US, investors are preparing for the possibility of Republicans losing their majority in one or both houses of Congress. Karni suggests that a divided government can sometimes stabilize markets by preventing drastic policy changes, but the current situation is more complex due to high federal debt and deficit financing costs. A divided government might block new spending but also hinder agreements on deficit reduction and tax policy. Increased tensions in the Middle East are another factor affecting both markets. Menachem raises the possibility of further regional conflict after the midterms, warning of its impact on the Israeli economy. Karni highlights that high energy prices could continue to fuel global inflation and pressure bond yields worldwide.