The views expressed in this column are solely those of the
author and do not reflect the views of SVB Financial Group, or Silicon Valley
Bank, or any of its affiliates. The Israeli economy
has remained strong throughout the financial crisis. Recent estimates of Q4 GDP
in 2010 have topped 4.5 percent. This solid economic performance, coupled with
relatively high benchmark interest rates at 2.25 percent and a hawkish central
bank have been attracting inflows of foreign capital. Against this backdrop, the
Israeli shekel has steadily strengthened, gaining 6 percent through 2010. This
steady and predicable appreciation of the shekel has been disrupted early in
2011 by two key events: 1) the introduction of reserve requirements on foreign
exchange derivative transactions and 2) political turmoil and social unrest in
Egypt. Investors in Israel and perhaps emerging markets in general are now
reacquainting themselves with the concept of geopolitical risk.
The
Central Bank of Israel has been actively intervening in the foreign exchange
market to weaken the shekel since 2008. The goal of this intervention has been
to assist the export sector, which accounts for about 40 percent of GDP. While
this policy of active intervention is credited with helping Israel's economy
weather the post-crisis global slowdown, it has been widely criticized not only
by the Organization for Economic Cooperation and Development (OECD), but also by
the two previous Israeli central bank governors. Regardless of this criticism,
on Jan 19 2011, the current central bank governor Stanley Fischer, took
additional measures to slow the appreciation of the shekel by introducing a 10
percent reserve requirement on foreign exchange derivative transactions in
excess of $10 million per day. The uncertainty caused by this changing
regulatory and liquidity environment caused a sharp reversal of shekel gains
(Figure 1).
More recently, the political turmoil in Egypt, touched off by
similar events in Tunisia, has added another dimension of risk to the outlook
for the shekel. Since the outbreak of popular protests in Egypt against
President Hosni Mubarak's regime on January 25 the Israeli shekel has again been
on the defensive. In response to dim economic prospects, political corruption
and widespread police brutality the people of Egypt have called for Mubarak's
removal from power. While these protests have been largely secular in nature,
regional analysts, U.S. and Israeli leaders fear that a power vacuum caused by
the removal of Mubarak may be filled by Islamist concerns hostile to Israel,
potentially destabilizing the region.
Egypt, the most populous Arab
nation in the Middle East, is currently regarded as Israel's most important
relationship in the region. The 1979 Israeli-Egypt peace treaty, which has been
honored by the embattled President Mubarak despite widespread disapproval among
the Egyptian population, has given Israel a degree of comfort and security along
its southern border. That security may be at risk if Egypt's next leader
abandons Mubarak's moderate stance toward Israel and the U.S. The irony, of
course, is that the very democracy and freedom of choice that the U.S. and
Israel promote is exactly what will now introduce the greatest risk factor for
regional stability and Israeli security.
Indeed, the largest and best
organized opposition group in Egypt, the Muslim Brotherhood, is hostile toward
Israel, openly disapproves of the 1979 peace treaty and is a known supporter of
the Palestinian movement Hamas. Although the Muslim Brotherhood has maintained a
noticeably low-profile throughout the unrest, the movement would likely seize
any opportunity to play a greater political role in the post-Mubarak era. While
it is clear that the Egyptian protests have not been overtly religious in
nature,
The Economist estimates that the Islamist brotherhood movement
would likely capture a fair percentage of support if free elections were held.
For Israel, the possibility of such a shift in power is deeply threatening,
reminiscent of the 1979 Iranian revolution which dramatically altered the
political and strategic landscape. That being said, it should also be noted that
any shift in stance toward Israel by the post-Mubarak government would surely
jeopardize the $1.3 billion a year in military aid that the U.S. funnels into
Egypt.
From a fundamental perspective, although the outlook for the
Israeli economy remains positive, political risk factors and concerns about
broader regional stability may continue to weigh on the shekel in the near term.
From a technical standpoint, however, the outlook for the shekel remains
positive. The January sell off that reached 3.7500 (Figure 2) tested two forms
of technical resistance — the long-term downtrend that reaches back to April
2009 and the 200 day moving average. A clear break back above those resistance
levels would suggest that an important reversal is in place. The initial upside
target of such a reversal would then be in the 3.90-3.92 range. Although these
resistance levels were briefly broken in the January run-up to 3.7500, the
subsequently quick sell-off raises doubts about the shekel's ability to break
higher. Consolidation over the next few weeks in the 3.61 – 3.64 range before
either resuming the downtrend or re-testing the January highs looks likely.
Scott Petruska contributed technical analysis to the
article. Foreign exchange transactions can be highly
risky, and losses may occur in short periods of time if there is an
adverse movement of exchange rates. Exchange rates can be highly
volatile and are impacted by numerous economic, political and social
factors, as well as supply and demand and governmental intervention,
control and adjustments. Investments in financial instruments carry
significant risk, including the possible loss of the principal amount
invested. Before entering any foreign exchange transaction, you should
obtain advice from your own tax, financial, legal and other advisors,
and only make investment decisions on the basis of your own objectives,
experience and resources.