Political and Economic Volatility Put Israel’s Currency in the Crosshairs
As Israel’s ruling coalition welcomes a new far-right partner, how will political volatility affect the shekel?
Birgir Haraldsson and Mario Manna
In mid-May, Israeli Prime Minister Benjamin Netanyahu sprung a surprise: he shook up his Likud-led coalition, inviting the Yisrael Beiteunu party to join the government. Netanyahu has endured a volatile relationship with Yisrael Beiteinu’s leader, Avigdor Lieberman, over the years, but striking a deal with the far-right, ultra-nationalist party allowed him to expand the ruling coalition’s representation in the Knesset to 66 seats (out of 120) from 61. In the weeks before and following Netanyahu’s coalition surprise, the Predata Political Volatility Index (PVIX) for Israel has remained on a steep ascent. Concerns regarding Lieberman’s appointment as defense minister have been front and center, with many fearing this will push an already intransigent government in an even more nationalistic, militant direction.
The Predata Volatility Index (PVIX) is a rules-based measure of a country’s political volatility, generated daily by monitoring multiple digital conversations taking place in the host country’s language(s) from a wide cross-section of collaborative and social media sources. The Israel PVIX’s 28-day moving average, a trend measure that smooths out the choppiness in the raw index and better captures long-term political volatility inflections, has climbed particularly rapidly in recent weeks, suggesting a renewed intensity to the digital discussion of domestic political developments (see chart below). The trend measure is now at its highest level in roughly three years, which signals that this event may well have a durable impact on Israel’s political climate. As things stand today, we seem far from marking a climax of this ascent.
This escalation of political volatility is interesting in the context of recent economic developments. From a market perspective, the question to ask is: will economic volatility now compound this fresh spike in political volatility to the detriment of the shekel?
Some economic context. Israel’s growth-inflation balance has soured in the last few months. Recall that GDP growth in the first quarter was far lower than expected, at 0.8% quarter-on-quarter annualized (versus a consensus expectation of 2.6%); as this growth moderation sets in, we’ve seen inflation slipping further from the target range as well. Stripping out energy costs, inflation dropped to its weakest point on record in April. Inflation expectations remain low as well. The charts below illustrate this moderation in both growth and inflation.
In line with these developments, the Bank of Israel’s messaging took on a more dovish tone in May, with officials warning that “risks to growth have increased.” The weakness in the export sector touched a nerve, with the central bank stating in its communique that the “intensifying decline in exports in recent months” has further cemented its view that policy will remain accommodative for a “considerable time.” With global export order orders contracting at their steepest pace in three years, this will remain a source of policy discomfort. Meanwhile, the nominal trade-adjusted shekel is today at its strongest point in 15 years. As Israel’s growth-inflation balance sours, is monetary policy flexible and accommodative enough? This is the crux of the issue.
The market is pricing in a 33% chance of a rate hike over the coming 12 months. But the souring of the growth-inflation balance points policy in the other direction, even as the Bank of Israel has little (no) room to cut. How this saga unfolds over the medium term will require careful attention. The economic context and the market’s pricing structure suggest that volatility could increase over the coming months due to economic factors, compounding the spurt of political volatility we’ve seen in recent weeks. In the fallout from this jolt of double volatility, a too-strong shekel looks likely to be the primary casualty.
Birgir Haraldsson and Mario Manna are founders of Nightberg, a NYC-based global macro strategy firm.