Best EM currency trade of 2023 hinges on shekel finding old form

A rare moment of Israeli market turmoil may be creating this year’s best currency trade.

Analyst estimates compiled by Bloomberg show the shekel strengthening by about 11% this year, surpassing forecasted gains for every other developing currency from South Korea to South Africa. That would mean a reversal in its recent fortunes: the Israeli currency has been one of the world’s worst performers over the past month, hit by protests over a controversial judicial reform proposal and a rare dispute over central bank autonomy.

The big question for traders now is whether the shekel’s newfound political sensitivity has become a permanent feature, or just a passing fad. If traditional market forces reassert themselves and the shekel returns to form, then the selloff is already overdone and it’s set to rebound, they say.

Over the past decade, the shekel is the world’s only major currency to strengthen against the dollar, becoming more correlated with global technology stocks than domestic political or economic drivers. But that relationship began to break down in January as protests against Prime Minister Benjamin Netanyahu’s judicial plans swelled, a deviation that’s continued since.

“We do not see a paradigm shift at present,” said Geoffrey Yu, a currency and macro strategist at BNY Mellon in London. “For the first time in nearly two years, our clients are flat the shekel and there is scope for further gains or purchases up ahead.”

Israel’s 10-year real yield rose 37 basis points since the start of the year to a nine-year high of 1.21% on Thursday.

Goldman Sachs Group Inc. has estimated that the currency carries a new political risk premium — which the US bank defines as the share of its cumulative performance that’s not explained by global market variables — of about 8%. It expects short-term pain for long shekel bets, but warns that the central bank could intervene if it’s unhappy with the decline.

From a current-account surplus to technology investment and increased natural gas exports, the backdrop has long been favorable for the Israeli currency’s appreciation. And with local institutional investors allocating more capital toward equities abroad, their hedging of foreign-exchange risk ensured the shekel often moved in sync with US markets.

But now, even looking beyond the politics, the outlook has grown less upbeat. A deepening slowdown in the tech industry and weaker exports are providing less support to the shekel just as other risks mount.

Intervention risk

Still, Peter Kisler, a London-based hedge fund manager at Trium Capital, said he’d be wary of getting on the wrong side of the Bank of Israel.

“We are tactically long, as downside should be capped by intervention if the selloff gets too extreme,” he said. “We are not ruling out further shekel weakness, but the balance of risks seems skewed to the upside.”

History is on the currency’s side. March has traditionally been the shekel’s strongest month, and it has also tended to gain in April, according to its 15-year average return. That might be due to dividend and interest rate payments to Israeli investors, Coex Partners said.

The currency may strengthen to as much as 3.4 per dollar by early May, said Henrik Gullberg, macro strategist at Coex in London. Those are levels consistent with market variables such as Israel’s interest-rate differentials, relative equity performance, credit-default swaps and the broader sentiment toward the dollar, he said.

The fact that the shekel is “so out of whack with traditional drivers” suggests that the probability of a snapback is growing, he said.