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.
I find it amazing how a country of just over 7.5 million people
with the geographical size of New Jersey has to defend itself on so many fronts.
Israel is surrounded by its sworn enemies. Under Israeli law Yemen, Syria, Saudi
Arabia and Iraq are considered enemy countries. Next door, the Lebanon-based
Hezbollah conflicts appear to have no end in sight. The leader of the
Palestinian Authority Fatah organization was quoted as saying "all of Israeli
society is a military society, and therefore a military target." Israel is
concerned about its neighbor to the south as Egypt tries to find its way with a
newfound democracy. Welcome to the neighborhood. Even Bolivia and Venezuela have
jumped on the radical band wagon and have suspended political and economic
relations with Israel.
Despite such obstacles, Israel has become one of the most
stable and prosperous nations in the Middle East. I am by no means an expert on
Middle East relations, nor can I attempt to describe the long-term conflict
between Israel and its neighbors. However, there is another topic that is closer
to my line of work. That is the battle of Israel's growth, inflation, and the
affect on its currency, the Israeli shekel (ILS).
Israel's economic recovery from the recent global economic
downturn has been tremendous. The latest GDP number was slower than the 7.6
percent in the fourth quarter, the fastest in four years. However, GDP has still
managed to expand an impressive 4.8 percent for the first quarter of 2011,
higher than what was previously estimated. The central bank of Israel expects
the economy to expand 5.2 percent this year. Unemployment fell to 6 percent in
the first quarter from 6.5 percent in the fourth of 2010. Consumer prices rose
0.5 percent in May and annual inflation is growing to 4.1 percent from 4
percent. This is the fifth month inflation has exceeded the target rate of 1
percent to 3 percent target range.
Inflation and higher interest rates have been the driving force
behind the ILS move higher, now trading near 3.42 ILS per 1 U.S. dollar. The
euro region has raised rates only 25 basis points in 2011 to 1.25 percent, while
Federal Reserve Chairman Ben S. Bernanke said this month that stimulus is still
needed to help a "frustratingly slow" U.S. recovery. Israel's accelerating
growth has pushed central bank Governor Stanley Fischer to raise the benchmark
interest rate four times this year to 3.25 percent, the fourth biggest increase
after Belarus, Chile and Brazil. Israel's interest-rate swaps continue rising
above contracts of the U.S. by the most on record. The average spread since 2005
between the two swaps, which investors use to fix borrowing costs in the future,
has been 135 basis points. The spread between Israel's five-year interest-rate
swaps and similar maturity U.S. notes rose to 282 basis points, the biggest gap
on record. These higher rates have enticed capital from offshore and kept demand
for the shekel. The ILS is up over 12 percent in the past year, making it the
best performer among Middle East currencies.
The Old Guy
It was only a few weeks ago Bank of Israel Governor Fischer
wrote, "An exceptional and unplanned opportunity has crossed my path, one that
may never again present itself, to run for the head of the IMF. After much
deliberation, I have decided to pursue it, despite the fact that it is a
complicated process and despite the possible obstacles." Israel's most respected
central banker had thrown his hat into the ring after Dominique Strauss-Kahn,
who resigned last month as managing director, after he was charged with
attempted rape in New York. Fischer, who was the IMF's first deputy managing
director in 1994, helped end crises in Mexico, Russia and Southeast Asia. He
seemed like a qualified replacement. Not so fast. The IMF rejected him because
Fischer, 67, is older than the maximum age limit of 65. The rejection was not
what he had hoped, but will be beneficial to the ILS. His presence will provide
continued economic stability in Israel. Since Fischer took office as Bank of
Israel governor six years ago, the local stock index has gained about 80 percent
while the shekel strengthened 29 percent during the same period. Many believe
his skills helped Israel recover from the global recession faster than many
other developed economies. The IMF loss and Israel's gain should maintain market
confidence, creating more demand for the ILS.
Without doubt, the widening interest-rate differentials between
Israel and developed economies will continue to favor the shekel. In an attempt
to reduce the appreciation pressures, the Israeli government has introduced
measures to curb the influx of "hot money." A 10 percent reserve has been placed
on banks' derivative transactions with non-residents. The Ministry of Finance is
also pressing ahead with its plan to eliminate a tax exemption that foreigners
currently enjoy on their profits from short-term government debt. However, the
legislative approval for this is unlikely until later this summer. The
conclusion is until the U.S. economy turns around and/or the Israeli cools off,
there should be little reprieve for demand of Israel's currency.
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. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
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.