The Israeli government bond market is showing worrying signs. This week, the yield on 10-year bonds rose above 5% for the first time since 2011. Meaning: demand for the Finance Ministry's large debt offerings is declining, and the country is forced to pay higher interest. The 10-year bond is considered a “benchmark,” a comparative measure of the state of the domestic economy compared to the world.
Kobi Levy, head of market strategy at Bank Leumi, explains: “The government’s fundraising needs have increased, the volume of Finance Ministry bond issues has increased and the deficit has ballooned, and Israel is issuing more bonds than usual.” Levy points to data released by the Bank of Israel, which shows that foreign investors have sold government bonds in recent months. “As a result of increased supply, fundraising meets limited demand, and a gap has been created that has led to a gradual increase in market returns,” he says.
Mizrahi-Tefahot Bank chief economist Ronen Menachem attributes the rise in yields to the complex geopolitical situation with the war in Gaza ongoing for nearly eight months, the IDF in the midst of a major operation in Rafah, increasing international pressure on Israel, and ongoing conflict. On the northern border are tens of thousands of evacuees who do not know when they can return home.
“It is not due to inflation and it is not due to differences in the impact of central banks’ interest rates, as there is no change in estimates that both the US Federal Reserve and the Bank of Israel will not cut interest rates soon,” says Menachem. “This leaves the security and geopolitical deterioration as the main driver.” for the behavior of bonds.”
Israeli bonds are trading with a BBB Minus rating, which is much lower than the official rating given by rating agencies. In market terms, the exposure of Israel's ten-year dollar bonds is priced slightly higher than in countries such as Peru, Mexico and Hungary.
The foreign exchange market reflects a different reality
The foreign exchange market reflects a completely different reality. The shekel-dollar exchange rate, which has been very volatile since the beginning of 2023 due to judicial reform legislation and the war, has been surprisingly stable over the past two weeks, with the rate ranging between 3.66-3.70 shekels/dollar. The entry into Rafah, the request to issue arrest warrants against the Prime Minister and the Minister of Defense, the European Union's recognition of the Palestinian state – all of these things suddenly were no longer crucial for an indicator characterized by such high volatility.
The bottom line is that the two markets – bond markets and foreign exchange markets – tell a very different story for foreign investors. Levy explains that “debt is mainly affected by financial considerations, while the shekel exchange rate is also affected by real considerations.” He says the Israeli economy, and the high-tech sector in particular, is showing strong export activity. “As a result, exporters in Israel have to convert foreign currencies and buy shekels in order to finance activity in Israel. This process creates pressures that support the appreciation of the shekel in the long term. On the other hand, in the short term, negative sentiment creates pressures for the shekel to fall in value, and these The forces balance each other out.
On the other hand, in the debt market, which is mainly affected by financial activity, there is a common phenomenon – the volume and number of bond issues have increased, and the deficit has also increased. These drive an increase in yield.
Menachem, for his part, explains that the shekel-dollar exchange rate had been pricing in risks for a long period of time, and was simply ahead of the debt market: “First of all, we are in an environment of excessive depreciation of the shekel versus the shekel “should” be stronger under conditions More routine, the decline is supposed to be about 10%, so the foreign exchange market reflects the problematic environment, and that was earlier compared to the bond markets.”
Another difference between the markets, according to Menachem, is the increase in foreign exchange balances held by the Bank of Israel. “The Bank of Israel’s policy of selling foreign currencies, if it comes to the conclusion that the value of the shekel is depreciating at an economically unjustified rate, remains in effect.” On the other hand, there is no such declarative policy for the Bank of Israel to buy government bonds if yields on them rise at a sharp and rapid rate. “This could also explain the difference in the behavior of the two channels,” he concludes.
Responsible fiscal policy will help
The expectation that the Bank of Israel will not cut interest rates, unlike a few months ago, also has an impact. Levy explains that lower expectations contributed to increased returns in the short term, and increases began to flow into the long term as well. The foreign exchange market and government bond yields also trade in a negative relationship in the long term, and Levy adds, “As bond yields rise, the demand for financial investments in shekels should increase.”
Looking to the future, Menachem says: “If the Bank of Israel can announce the purchase of government bonds, this is an acceptable tool. If that happens, we may see a fairly large correction in redemption yields, as happened for the shekel. In order to see an improvement in the debt market “We will also have to see an improvement in the geopolitical and financial picture.”
Published by Globes, Israel Business News – en.globes.co.il – on May 30, 2024.
© Copyright Globes Publisher Itonut (1983) Ltd., 2024.
