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Monday, June 9, 2014

The Israeli Shekel is strengthening against the dollar…Why? What is the future outlook?

Israeli Shekel per $ One Year as of June 8, 2014

The Israeli Shekel (NIS) has been on a long term strengthening trend hitting a 12 month high (dollar low) of under 3.4500 in mid-May (see chart above). In May of 2012 it traded over 4.000.
While it is notoriously difficult to forecast exchange rates several factors are likely to continue:
What are the factors affecting the exchange rate?
Interest rate differential between the US dollar and shekel. The US central bank has indicated short term interest rates will remain low in the near future  which is likely to keep Shekel interest rates remain higher than the US dollar. The interest rate differential between the NIS and the Euro can affect both the Euro/NIS rate and the $/NIS rate. Recent activities by the European Central Bank indicate a long future period of extremely low interest rates.

Speculative flows into the shekel. As shekel rates remain lower speculators from around the world purchase dollars to earn the extra interest. In the financial markets this is called “hot money “because it moves quickly in response to market conditions. Furthermore if these speculators feel the trend is their friend they will increase their shekel purchases. An additional factor is inflows from Israeli exporters, foreign investors and corporations expanding their operations in Israel.
Policies by the Israeli Central Bank (Bank of Israel)
In an effort to stabilize the exchange rate the Bank of Israel has been “intervening “in the currency market buying dollars and selling shekels. Despite purchasing over $300 million dollars since the middle of 2012 the shekel has continued to strengthen. Since 2008 the bank has purchased $ billion and the rate is at virtually the same rate as 6 years ago.
Not only has the central bank intervention not slowed the rise of the shekel it has created losses for the Central Bank. As the dollar strengthens/shekel weakens the dollars held by the Central Bank decline in value.

But throughout financial history and around the world intervention seldom works to reverse a long term trend created by fundamental economic conditions. This has been the case for the Bank of Israel as well. Despite purchases of over in the last months the dollar has fallen from a 2013 high of over 4.0 to a recent low below 3.45
The Bank of Israel’s dilemma:
Central banks can only target one rate through their policies: either the exchange rate or interest rates. In order to reduce the long term attractiveness of the shekel, the Bank of Israel would have to lower interest rates….But lower interest rates lower mortgage rates and increase demand and prices for housing exactly the opposite of government policy.
Most recent economic data has indicated  slower growth in the Israeli economy and talk has increased of interest rate cuts. Even if that were to occur NIS rates would remain above those of both the dollar and Euro

What is the future outlook?
Exchange rates are very difficult to forecast and virtually impossible to forecast on a short term basis. The shekel may well have a short term weakening of 1% to as much as 5% without changing the fundamental trend. In fact on May 19 the exchange rate moved from a low of 3.4420 to 3.4950 before closing at 3.4750… a range of 1.5%.

As long as interest rate differentials vs the US and the ECU remain positive for the shekel vs. the dollar  and the Euro it will be a short term factor in the currency’s favor.  Even if the Bank of Israel cuts rates in response to recent slower economic growth and low global interest rates, the interest rate differential will remain positive for the NIS

Several long term factors argue for continued strength in the Israeli currency

Inflows from non-Israeli corporations and investors. Investors putting money into Israeli startups need to buy shekels to do so. Multinational corporations such as Intel already established in Israel need shekels to cover ongoing expenses and business expansion.

Corporations that have done ipos in the US or sold out to US companies have dollars to repatriate.

Israeli exporters a large part of the economy have dollars to repatriate from sales abroad.

If the above groups fear more weakening of the dollar they will accelerate their shekel purchases creating more momentum for a weaker dollar.

An important longer term factor will be the development of large natural gas reserves. Investments during the development stage will bring inflows of from abroad and purchases of local currency. Once developed gas exports would both generate revenues and reduce the need for $ denominated energy imports.

Recently appointed Central Bank Governor Karmit Flug acknowledged that the Bank of Israel has been intervening to slow the currency movements to give time for corporations to prepare themselves. But she noted the strength of the shekel reflects confidence in the Israeli economy which she expects to continue The central bank continues to indicate that while it may act to moderate exchange rate movements it cannot reverse long term trends based on economic fundamentals.
Perhaps those that would be adversely affected by a further weakening of the dollar vs. the shekel might take Ms. Flug’s advice and also prepare themselves for the possibility of a future stronger shekel.

On June 9 both Governor Flug and Bank of Israel  head of capital markets gave little indication of concern about the stonger shekel in their speeches at the Herziliya Conference.

The Marker/Haaretz reports:
Flug stated:

“The exchange rate is a very important data point that we look at,” Flug told the Herzilya Conference, an annual gathering of policy makers, on Monday. “We look at the dollar because of its impact on inflation. In the past, this impact was very strong, while today it is moderate. It has also had an impact on employment and [economic] activity.”
Flug said the shekel had experienced a sharp appreciation early last year but that the trend had moderated more recently.
Abir ;
Andrew Abir, the head of the Bank of Israel’s markets division, told the committee he had seen no signs of speculative trading recently 
But, as the article notes the exchange rate has become a political issu as the Marker reports:
In a Knesset Finance Committee meeting on Monday, lawmakers called for the central bank to set a minimum exchange rate for the shekel....the Manufacturers Association, a trade group for the country’s biggest industrial companies, reiterated a call to set a floor of 3.8 shekels to the dollar. Israeli high-tech leaders issued similar warnings on Sunday.

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