A political showdown in Israel that swept up the shekel this year is having less sting as carry traders abandon it as a funding currency.
(Bloomberg) — A political showdown in Israel that swept up the shekel this year is having less sting as carry traders abandon it as a funding currency.
With Israel again consumed by protests over the government’s controversial judicial overhaul, the shekel has proven surprisingly resilient, on track for its best week since early June with a gain of about 2.5% against the dollar.
For BNY Mellon, it’s the outcome of a shift in the market by carry-trade investors who borrow in countries with lower interest rates to seek better returns. On Monday, the Bank of Israel paused a record stretch of monetary tightening but signaled a “real possibility” rates will need to go up further in the future after already rising to the highest since 2006.
“We see the shekel as undervalued and it will likely recover as US rate expectations peak,” said Geoffrey Yu, a currency and macro strategist at BNY Mellon in London. “The carry trade is unwinding globally — and as the shekel is considered a savings-heavy funding currency, we see it as in a good position to strengthen.”
On the same day that Israel’s central bank delivered what Goldman Sachs Group Inc. called a “hawkish hold,” lawmakers moved forward with a key element of the controversial judicial overhaul that’s divided the country and unnerved investors.
The standoff with Prime Minister Benjamin Netanyahu’s government, the most religious and nationalist in the country’s history, has spilled over into the foreign-exchange market. Since the cabinet began to proceed with its plans in late January, the shekel is among the worst performers in the basket of expanded major currencies tracked by Bloomberg.
Until this year, the shekel was more correlated with global technology stocks than domestic triggers. That relationship broke down as protests against the overhaul mount.
The political uncertainty contributed to a depreciation that fed into consumer prices to keep inflation above the government’s 1% to 3% target range.
While forced into more monetary tightening than it first envisaged, the Bank of Israel’s cumulative rate hikes fell slightly short of what the US central bank delivered during its campaign. The divergence allowed investors to borrow at lower rates in Israel and convert the proceeds into a currency they can lend out for a higher return.
The turbulence in Israel will likely leave policymakers on alert, with one-year currency swaps indicating investors see the base rate at 4.845% in a year from the current 4.75%.
In the US, inflation slid to a more than two-year low in June, ahead of what’s expected to be another rate hike later this month. But there’s now a better-than-even chance that a July 26 increase, which would take the benchmark US rate to 5.5%, could be the last in quite a while.
The debate in Israel over the judicial overhaul is far from over, leaving the shekel vulnerable to further bouts of weakness, according to Goldman. While strategists at Deutsche Bank AG expect Israeli bonds to extend their recent rebound on signs that inflation may have peaked, they are cautious on the currency, according to a report last week.
Geneva-based GAMA Asset Management, which invests in global debt and also oversees a macro fund, is waiting for an easing of political tensions and compromise before making any bets on the shekel’s advance.
“Most of the pain is behind us, but the headline risks are still there for some time,” said Manuel Streiff, a founding partner of the firm.
Still, the backdrop remains favorable for the shekel. Israel, a major destination for technology investment, has long run a current-account surplus and become an exporter of natural gas.
GAMA Asset Management bought the nation’s local-currency bonds six weeks ago when the 10-year yield was approaching 4%, a level it considered as “very attractive for a top quality sovereign issuer,” Streiff said.
“We hold a positive general view on the shekel, mainly on the back of structural positive tailwinds,” Streiff said.
–With assistance from Gwen Ackerman.
(Updates shekel’s performance in second paragraph.)
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