Israel's Credit Rating at Risk Amid US Relations Strain

The deterioration of relations between Israel and the United States could pose a significant threat to Israel's credit rating, though financial markets have not yet fully priced in this risk, according to Alex Zabezhinsky, Chief Economist at Meitav Brokerage. In his weekly macro review, Zabezhinsky warned that recent events highlighted Israel's declining standing in Washington. He cited the US President's announcement of aid suspension to Israel on election day and the Vice President linking ties with Israel to election losses as indicators of this trend. These developments could have economic consequences extending far beyond the aid itself, as American support is considered a cornerstone of Israel's credit rating. Zabezhinsky recalled that Moody's had already cautioned in 2025 that a substantial erosion of Israel's relationships with key allies, including the US, would significantly impact its credit rating, a point also emphasized by S&P. The potential economic cost is substantial: a Bank of Israel calculation presented by Zabezhinsky suggests that if defense expenditures increase by approximately NIS 35 billion annually, Israel's debt-to-GDP ratio could reach 83% within a decade with continued US aid, compared to 86% without it. This 3 percentage point difference could strain Israel's fiscal situation and its ability to withstand further economic shocks. Beyond the direct budgetary impact, a downgrade could increase the government's borrowing costs. However, the review indicates that investors are not yet giving significant weight to this risk, as evidenced by Israel's risk premium measured by CDS contracts and dollar bond spreads, which barely reflect the worsening US relations. The bond market has shown signs of concern since the Israeli elections, with the TA-125 index falling about 4.6%, similar to declines in the S&P 500 and emerging markets. The shekel weakened by 4.2% against the dollar, though Zabezhinsky notes most of this depreciation aligns with the historical correlation between the shekel and the US stock market. Notably, Israeli government bonds have shown unusual weakness, with the yield on ten-year shekel bonds rising about 0.1 percentage points since the elections, while yields in other major countries have decreased. Consequently, Zabezhinsky remains cautious about strategic investments in risky assets in Israel, anticipating that government formation might support short-term gains but preferring medium-term government bonds, particularly inflation-linked ones.