The ongoing conflict between Israel and Hamas in the Gaza Strip and the complex situation on Israel's northern border means that the Israeli economy faces a great deal of uncertainty, which can be expressed in several metrics. For example, the direct confrontation between Israel and Iran contributed to the weakening of the shekel and pushed the risk premium on government bonds to their highest levels in more than a decade. By contrast, during the Easter holiday that ended on Monday, when talk of an agreement with Hamas for a ceasefire and the release of Israeli hostages became prevalent, the value of the shekel rose sharply, and the Tel Aviv Stock Exchange, which resumed its activity yesterday, also strengthened. Due to reports of the deal, major indices rose.
With the help of three senior analysts, we attempted to chart what would happen to the local economy in each of the following scenarios: signing of a ceasefire and prisoner exchange agreement; Further escalation, including large-scale Israeli military operations in the Gaza Strip; Things continue as they are, without any major escalation in the conflict, but there is no ceasefire agreement either.
1. The deal may boost the value of the shekel
One of the key and fastest-reacting measures of sentiment about the local economy is the shekel-dollar exchange rate. Despite the sharp rise in the value of the shekel in the past few days, with increasing talk of a deal with Hamas, the shekel to the dollar is still priced at a high risk premium. So far this year, the shekel has depreciated by 4% against the dollar.
Before 2023, the shekel was one of the strongest currencies in the world, but last year, even before the outbreak of war, its value declined as a result of the government's judicial reform plan and the violent reaction to it.
According to various estimates, the shekel exchange rates against the dollar have a risk premium of about 0.30 shekels. Evidence of this can be found in the forecast issued by Bank of America a few days ago, which expects that the shekel will gradually rise in the coming quarters and that the shekel-dollar rate will reach 3.5 shekels/dollar by early next year, assuming that the prevailing uncertainty prevails. In Israel it is less. The current price is about 3.73 shekels/dollar.
“Until the end of last week, the markets did not estimate a high probability of a situation in which a ceasefire would begin and a hostage deal would be drawn up between Israel and Hamas, so the shekel continued to weaken against the basket of currencies and the risk premium rose in Israel. Shafir points out that the main factor that affected the performance of Israeli markets recently is the escalation towards Iran, which raised fears of a regional conflict, and in the past two weeks, this fear has subsided somewhat, as the markets have realized that there will not be one Renewed escalation with Iran, but at the same time it did not expect to reach an agreement.
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“A deal to release the hostages could put progress in normalizing relations between Israel and Saudi Arabia back on the table, as US Secretary of State Blinken shuttles around the Middle East. This would lead to a corresponding decline in the risk premium.” For Israel, Shafir says: “To strengthen the shekel.”
On the other hand, he says, if negotiations on a hostage release deal collapse, it could return the shekel to the downward trend seen so far, while the risk premium would rise. The big question is, how much? These trends will not be very strong, says Shafrir, because the shekel exchange rate against the dollar and the risk premium are high anyway. In addition, he says, any assessment is difficult because “the impact of entering Rafah will depend on the headlines around the world, and on the operation itself.”
Yoni Fanning, chief strategist at Mizrahi-Tefahot Bank, explains that the global foreign exchange market showed very high pressures in April, and that this was not just a local phenomenon. “It's happened in markets around the world. We've seen it in the risk premium in the oil market as well, and in the rise of the dollar against a basket of currencies, due to global tensions. The fear of an all-out conflict between Israel and Iran was very high,” says Fanning, in his view. If an agreement is reached between Israel and Hamas, it will cause the value of the shekel to rise significantly and he sees a rate of 3.65 shekels/dollar as a certain possibility if we see an agreement reached.
2. The stock market will not calm down quickly
Last year, and this year so far, the local stock market has underperformed the leading global markets. So far this year, the Tel Aviv 35 Index is up about 3%, while the return on the S&P 500 is almost double that. How will the ceasefire affect the stock market?
“The strength of the rally will depend on the agreement and what it looks like, whether it is permanent and sustainable or not,” says Jonathan Katz, chief economist at Leader Capital Markets. He says that the scenario of the return of the hostages and a long-term ceasefire will lead to understandings and calm the situation in the north as well. He says: “A ceasefire in the south will spare us the need to enter Lebanon and open another front. If the markets understand that, this will be a positive scenario,” adding that the rise in the markets will be comprehensive. This will happen in the stock market as the value of the shekel rises and the risk premium in Israel decreases.
Katz says Israeli stocks have been dealt a double blow. “Social unrest and the judicial reform program in early 2023 led to a negative outlook for the markets and to negative forecasts on the part of rating agencies, even before the war. To this was added the geopolitical tension since last October. It does not seem to me that we will close this gap, because it stems from other factors that will not necessarily disappear.
On the other hand, Bank Hapoalim's Schwerer estimates that we will not see a sharp movement in either direction. “The stock market will be affected by geopolitical events, because they tend to be sensitive to them,” he says. “However, the Israeli stock market has performed poorly since the beginning of 2023, so it is not certain that we will see a strong impact on the markets, given the high degree of stress that is already prevailing.”
Fanning also doesn't expect the stock market to rise anytime soon. “In general, the stock market goes hand in hand with the foreign exchange market. But the risk premium is still high, so investors will not be in a hurry to return to the Tel Aviv Stock Exchange.”
3. Escalation will deepen the fiscal deficit
According to estimates by the Ministry of Finance and the Bank of Israel, the Israeli fiscal deficit in 2024 will reach 6.6% of GDP. But in the financial markets there are more pessimistic expectations indicating a deficit that may reach 8% in the current situation. International bodies and the Bank of Israel say that a severe escalation in the security situation, such as an all-out war in the north, will destroy expectations.
“We have received a large aid package from the United States ($26.4 billion), and this should help Israel’s financial situation,” Shafir says, stressing the importance of the aid. However, “any major escalation may lead to an increase in Israel's risk premium and its financial deficit.”
Katz, who in the distant past worked in the Budgets Department of the Ministry of Finance, explains that the deficit is affected by three unknowns. The first is American aid, which was hung in the corridors of the US Capitol, but was recently approved by Congress.
“The second unknown is the opening of a northern front and escalation. Such an event is not included in the budget, and could lead to a sharp rise in government spending. A ceasefire will remove this threat, and will of course be positive for the deficit.” Katz says.
The third layer is the possibility of a post-war economic recovery. Katz says the Israeli economy is standing up well so far, and further strengthening could increase tax collections and narrow the deficit on the revenue side.
Published by Globes, Israel Business News – en.globes.co.il – on May 1, 2024.
© Copyright Globes Publisher Itonut (1983) Ltd., 2024.
