What's up with the dollar?
Harel Pia VP Uri Rabinowitz: Only Chile's peso is stronger than the shekel.
Roee Bergman 18 Feb 08 18:36
The strengthening shekel refuses to drop of the newspaper headline and the pressure is growing on Governor of the Bank of Israel Prof. Stanley Fischer to cut the interest rate in order to help exporters suffering from the weak dollar in recent months. Under the circumstances, it is a good a idea to take a step back to examine the reasons for the strong shekel and whether an interest rate cut will help the dollar recover against it.
Harel Pia VP Uri Rabinowitz says, "There is only one currency in the world stronger than the shekel nowadays, and that is the Chilean peso." In an attempt to explain the present foreign currency market, he notes that, over the past year, there has been a rather strong correlation between emerging market currencies, which have strengthened sharply against the dollar. "If you look at the most popular currencies, such as Brazil's real and the Turkish lira, the level of clarity is even higher," he says.
Rabinowitz added that, until recently, the shekel went hand in hand with these currencies and it was possible to predict its direction on the basis of the behavior of the other currencies. However, there has been a change in the conduct of the shekel of late, and it has severed its link with other emerging market currencies. "The shekel is strengthening substantially against the dollar, where the trend of other currencies is different. This is a highly significant phenomenon because the correlation of the shekel with the other currencies lasted a very long time," he says.
The domestic market attributes one paramount factor to the shekel-dollar exchange rate - the interest rate gap between the shekel and the dollar. The credit crisis has caused the Federal Reserve Board to make two steep interest rate cuts back-to-back, amounting to 125 basis points, to 3.5%. The cut opened an interest rate gap in favor of the shekel by the same amount. The economic motive is clear: invest in the shekel and you'll get a higher return on your money than you'll get from the dollar.
It is necessary of course to add the risk component of the two markets to the equation, with the US market considered less risky that the Israeli market due to political and security factors at play in Israel because of the regional instability.
On the other hand, Israel's economy has shown extraordinary robustness in recent years, as seen in its GDP growth, falling debt-to-GDP ratio, and other variables, which have resulted in credit upgrades for the economy. In contrast, the US economy is in the midst of a credit crisis that is liable to push the world's largest economy into a recession - a scenario that is hard to imagine for Israel for the coming year.
Israel's ratings upgrade has narrowed the risk gap between Israel and other countries. The fairly attractive shekel interest rate, compared with the dollar, has strengthened the shekel, as domestic and foreign investors prefer to put their money in Israel by buying shekel denominated assets and selling dollars. The preference was different a few months ago, when the dollar interest rate was higher than the shekel interest rate, but given the current US economic circumstances, the gap had little effect on the exchange rate.
Rabinowitz says that under the current market conditions, with no expectations of an interest rate hike or inflationary outbreak, the yield curve is considered a significant factor affecting the strengthening of the shekel. "Assuming no drastic change in the current figures, no dramatic change in the shekel-dollar exchange rate can be expected," he said.
Rabinowitz concluded that, as Governor of the Bank of Israel Prof. Stanley Fischer claims, Israel's current interest rate was not a dominant factor in the strengthening of the shekel. However, Rabinowitz disagrees with Fischer that the all of the shekel's strength is derived from non-financial investment in Israel.
"Current figures are more solid for 5-6-year instruments. Ten-year instruments have a higher risk," he says. Looking ahead at the foreign currency market, he adds, "A lot of money has left the US and Europe in recent years, and the assumption is that as the situation worsens, the money will go back. The dollar's weakness is liable to affect the foreign currency reserves of emerging countries, which is why these countries tend to strengthen the dollar level in an attempt to prevent its further erosion."
Rabinowitz added that in the domestic market, in addition to the strengthening of the shekel, there has been a sharp rise in the standard deviation in dollar options. This means that the market expects a violent correction in the dollar against the shekel, which will put the domestic market back on the rollercoaster.
Published by Globes [online], Israel business news - www.globes-online.com - on February 18, 2008
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