Israel’s $70b shekel defence is tested in market showdown

The stare-down with markets followed the deadliest attack on Israel in decades, with hundreds killed on Saturday (Sunday AEDT) and Prime Minister Benjamin Netanyahu saying the fight against Hamas in the Gaza Strip would be lengthy and difficult.

The extraordinary intervention by the central bank marked the first time it had sold foreign exchange to prop up the shekel since it was allowed to trade freely.

Outlook unclear

The market verdict is not yet clear even as the fallout of the conflict reverberated across asset classes.

Yields on the government’s 10-year shekel bond climbed 22 basis points to 4.5 per cent, the highest since 2012. The price of Israel’s 100-year debt due in the year 2120 fell to 65.2¢ on the dollar, the lowest since it was sold in 2020.

The cost to insure the nation’s debt against default jumped 25 basis points to 84, the most since 2009. Options traders see about a 70 per cent probability that the shekel might weaken to 4 per dollar in a month – a level unseen since 2015 – compared with only an 18 per cent chance the day before the attacks.

Stock markets across the Middle East also fell amid concerns the war might escalate into a broader conflict. Israel’s benchmark TA-35 stock index plunged 6.5 per cent on Sunday but recovered some losses. It rose 0.9 per cent on Monday after losing as much as 1.3 per cent earlier in the day.

“In circumstances like this, maintaining stability is more important than levels,” said Geoffrey Yu, a currency and macro strategist at BNY Mellon in London. “In the short term, there will be some volatility in markets, but we expect this to be manageable. The liquidity support is expected and the Bank of Israel is very much experienced in such matters.”

Smoothing volatility

The central bank is dusting off a crisis-era playbook in steering the $US520 billion economy while also leaving room for manoeuvre during a national security emergency that could last for months.

The goal is to smooth out volatility in the shekel’s exchange rate and provide the necessary liquidity to support markets, according to the Bank of Israel.

Mr Benita said it was not defending any specific shekel level and currently had no plans to expand its support program, declining to comment on Monday’s interventions.

Policymakers previously resisted supporting the shekel even as investor concerns surrounding the government’s controversial efforts to weaken the power of the judiciary weighed on the currency for months. The shekel is one of the biggest losers this year among a basket of 31 major currencies tracked by Bloomberg.

A program of currency interventions begun more than a decade ago by then-governor Stanley Fischer to stem the surging shekel helped the central bank amass reserves that now surpass a third of gross domestic product. They stood at nearly $US199 billion at the end of September.

The consensus among strategists and economists so far suggests confidence in the shekel even as it has emerged vulnerable from months of political upheaval.

Citigroup does not “expect further sustained bouts” of the currency’s weakness, and HSBC Holdings said the “shekel is likely to stabilise”.

Besides the possibility of rate increases and expanding the scope of its existing program of interventions, the central bank could also opt to conduct bond purchases, a measure it used to support markets at the height of the global pandemic.

“This is clearly an extraordinary time for Israel and the central bank is likely to want to minimise the economic costs of the conflict as well as dampen any financial stability risks,” Deutsche Bank strategists led by Christian Wietoska said in a note.

Bloomberg