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Goldman Sachs warns of continued shekel ‘risk’ premium driven by judicial turmoil

Since the end of January, the shekel has ‘significantly’ underperformed global markets; investment bank sees further weakness risk for the currency in short term

Sharon Wrobel is a tech reporter for The Times of Israel.

A stock market ticker in the lobby of the Tel Aviv Stock Exchange, March 15, 2020. (Flash90)
A stock market ticker in the lobby of the Tel Aviv Stock Exchange, March 15, 2020. (Flash90)

Israel’s currency is likely to continue to suffer losses in the short term as the contentious plans for overhauling the judicial system fuels market concerns, warned US investment bank Goldman Sachs last week.

The shekel weakened 2.2% against the US dollar last week, hitting a three-year low after the Knesset passed the first reading of a bill to make controversial changes to the judiciary system, and has lost more than 6% of its value so far this month.

The Tel Aviv Stock Exchange’s benchmark TA-125 index dropped almost 4% last week and TA-35 index of blue-chip companies was down 3% compared with a 2% decline in the MSCI World Index during the same period.

“While significant political premium now looks to be embedded in ILS, risks remain for the shekel over the short run,” Goldman analysts led by Kamakshya Trivedi wrote in a research note to investors late on Friday. “The broader ILS trend this month clearly reflects not just global developments, but domestic ones.”

Prime Minister Benjamin Netanyahu’s hard-right coalition has prioritized the controversial proposals to transform the justice system, which are being spearheaded by Justice Minister Yariv Levin. The proposed legal overhaul would grant the government total control over the appointment of judges, including High Court justices, severely limit the High Court’s ability to strike down legislation, and enable the Knesset to re-legislate laws the court does manage to annul with a bare majority of 61 MKs.

The government has declared itself determined to press ahead with advancing the reform package at full speed, despite mass protests and opposition from leading economic voices and former policymakers calling for the protection of Israel’s democracy and system of checks and balances.

“With the increase in market concerns surrounding the judicial reform, a simple benchmarking exercise suggests that roughly 8% risk premium has appeared to build in the shekel (i.e. the share of ILS’s cumulative performance since domestic market volatility began in earnest in late January that is not explained by global market variables),” Goldman analysts wrote in the report.

Tech workers march in Tel Aviv to protest against the government’s planned overhaul of the judicial system, January 31, 2023. (Tomer Neuberg/Flash90 )

Goldman emphasized that since the end of January the “shekel has underperformed significantly what the Nasdaq and other market variables would imply,” pointing to an “unusual deviation” of the local currency’s historical close correlation with global tech stocks.

“This deviation has continued,” even after the Bank of Israel last week hiked interest rates by a larger-than-expected 50 basis points to 4.25% to battle inflation.

“The shekel has continued to underperform where it ‘should have’ traded based on global market variables alone and also its typical post-pandemic volatility,” according to Goldman. “Tactical views on whether the currency will return to its ‘global tech anchor’ will require more clarity on expectations of domestic policy.”

The ruling coalition’s plan to upend the judiciary has been weighing heavily on market sentiment amid fears over its negative impact on the country’s credit rating, which could trigger an outflow of capital and scare away investors. The Finance Ministry’s chief economist recently cautioned that the judicial plans are poised to crimp economic growth and foreign investment in Israel and central bank governor Amir Yaron is said to have warned the government that an economic crisis “could break out within a moment.”

“The key question, of course, is whether this risk premium will continue to build or start to abate, which in turn will depend on domestic political and macro developments,” Goldman analysts wrote. “Some risk premium may be warranted and may build further if market participants grow more concerned about domestic political developments.”

Goldman also weighed in on the possibility that the Bank of Israel could intervene in the foreign exchange market, if continued shekel weakness spurs inflation pressure as a decline in the local currency makes imports more expensive. Buying dollars to weaken the shekel is nothing new for Israel.

Illustrative photo of the new 100 Israeli Shekel bill on December 31, 2017. (Nati Shohat/Flash90)

The Bank of Israel last intervened in 2021 when it bought  $30 billion in foreign exchange to curb the rise of the shekel after it bought $20 billion worth of foreign currency in 2020. The bank has purchased billions of dollars annually as part of a strategy first put in place during the global financial crisis of 2008.

“Given the shekel’s idiosyncratic weakening in recent weeks, and the potential for spillovers onto domestic outcomes like inflation if it continues, one key question is FX management,” Goldman economists said. “While the Bank of Israel has been active in the FX market in the past, these interventions were part of an easing monetary policy stance (in order to prevent tightening from a stronger shekel) rather than responding to a repricing based on political factors.

“It remains unclear if or when FX interventions will be part of the discussion around the shekel.”

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