Growing fears of an escalation in the confrontation between Israel and Hezbollah in Lebanon have increased pressure on Israeli government bonds. Yields on long-term government bonds have risen in recent days, reflecting the increased risk that investors attribute to the state of Israel’s debt.
The yield on 10-year shekel government bonds is currently 5.2%, the highest level in 13 years and up more than 0.5 percentage points in two weeks. A year ago, the yield on the same bonds was 3.8%. The yield on 30-year shekel government bonds is currently 5.7%, compared with 4.1% a year ago.
The rise in government bond yields, of course, stems from falling bond prices. Ten-year shekel bonds are down 4.8% so far this year, while 30-year shekel bonds are down 13%. The drop is partly due to the sharp increase in the rate at which the Israeli government is raising debt to cover the costs of the war. In July, for example, the government will raise NIS 17.5 billion, double the amount it raised in the months before the war.
The importance of higher yields is that the government will have to pay higher interest rates to investors in new bond offerings. This is also due to Israel’s lower credit rating. In April this year, Standard & Poor’s downgraded Israel’s sovereign credit rating from AA- to A+. In practice, Israeli government bonds in dollars are priced in line with a much lower rating, somewhere between BBB- and BB+.
Another explanation for the drop in Israeli government bond prices is the massive sell-off by foreign investors since the start of the war. Modi Shafrir, chief financial markets strategist at Bank Hapoalim, notes that since September 2023, these investors have reduced their holdings of Israeli government debt by about NIS 23.5 billion, or 5% of their total holdings.
The yield on the benchmark 10-year US Treasury note is currently 4.46%, after rising from 4.2% over the past two weeks.
Another figure that indicates the increased risk attributed to Israeli government debt is the risk premium Israel bears, embodied in the 10-year credit default swap, a type of insurance policy against a borrower’s default. The CDS rate is currently at 176 basis points, its highest level in 11 years, reflecting foreign investors’ fears of a serious conflagration on the northern border.
In the past few weeks, more and more countries have warned their citizens in Lebanon to leave the country. The CDS rate on Israeli government bonds has been rising steadily in the past few months, and is now about 160 basis points higher than it was when the war broke out in October 2023. Before the war, it was about 80 basis points.
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International measures such as credit default swaps and Israeli government debt raised abroad suggest that “Israel’s risk premium has jumped,” says Amir Kahanovitch, executive vice president and chief economist at Profit Financial Services. “These are not healthy price levels, they were at war.”
“The risk premium that the Italian government took during the Covid-19 pandemic rose to 225 basis points,” Kahanovic reminds us. “When the pandemic ended, the premium was back to around 70 basis points. So the risk premium is not due to the government’s daily behavior. In a war, there is uncertainty, and we are threatened by missiles. CDS prices have risen more because of security risks than because of the country’s financial behavior.”
When it comes to shekel yields, Kahanovitch is less concerned. “The yield on Israeli government bonds doesn’t really reflect risk. You can look at Australia, which has a CDS rate of 11 basis points, probably the lowest in the world. Australian dollar-denominated 10-year government bonds are trading at a yield to maturity of about 5%. In my opinion, the high yields on shekel government bonds are mainly related to investors’ expectations about inflation.”
In late 2021, before interest rates started rising, anyone who bought a ten-year Israeli government bond was getting an annual return of less than 1%. Now, when the yield is over 5%, is such a bond an investment opportunity?
“Nobody has a crystal ball,” says Kahanovic. “We live in a world where we manage risk first and foremost. If people buy bonds whenever something like this happens, they will over time earn above-average returns. But we should emphasize the need for diversification.”
This article was published in Globes, Israeli Business News – en.globes.co.il – on July 3, 2024.
© Copyright Globes Publisher Itonut (1983) Ltd., 2024.