S&P cuts Israel’s outlook to negative, shekel hits new lows

Shekel trades at 4.08 vs. USD as S&P cuts credit outlook to negative

Israel's credit outlook has been downgraded by the third major credit rating agency that had previously maintained a stable outlook, casting a shadow over the country's assets as the war with Hamas continues to impact the economy.

The Israeli shekel has continued its decline against the U.S. dollar, trading around 4.0807 at the time of writing.

On Tuesday, S&P Global Ratings revised Israel's outlook to negative, following similar actions taken by Fitch Ratings and Moody's Investors Service. S&P pointed to the potential for the conflict to expand and have a more significant effect on Israel's economy and public finances than initially anticipated.

These decisions have raised the possibility of Israel seeing its first-ever credit rating downgrade. As geopolitical tensions remain, investors have become cautious about Israeli assets, particularly in anticipation of a potential ground invasion of Gaza. The Israeli Defence Force (IDF) recently carried out its biggest raid into the Gaza Strip since the Hamas attacks on October 7, in an effort to prepare for an eventual invasion of the enclave.

The shekel’s two-week decline has marked the longest losing streak for the currency in four decades. Some of Israel's hard-currency bonds have also reached record lows in value.

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Israel economy forecast: S&P sees war lasting “no more than six months”

Jerome Leibovici, CEEMEA Strategist at BNP Paribas, told Bloomberg that there could be more upward pressure on credit spreads going forward:

“The unscheduled review from S&P comes at a time when both USDILS and 5-year credit default swaps trade at decade highs. As the conflict ensues, there could indeed be more upward pressure on credit spreads. Additionally, the fact Israel bonds are not part of EMBI and are potentially owned as an off-benchmark position by international investors may exacerbate this,” he said, referring to a key emerging-market index.

According to research by Deutsche Bank, bets against the Israeli shekel surged in the week following the surprise attack by Palestinian militant group Hamas on southern Israel on October 7.

On Tuesday, S&P affirmed Israel’s rating at AA-, the fourth-highest score, but warned the economy is at risk of a sharp downswing in the months ahead. It now forecasts gross domestic product will shrink 5% in the fourth quarter from the prior three months amid disruptions related to security and reduced business activity.

In a statement, S&P analysts Maxim Rybnikov and Karen Vartapetov said:

“The Israel-Hamas war could spread more widely or affect Israel’s credit metrics more negatively than we expect. We currently assume the conflict will remain centered in Gaza and last no more than three to six months.”

Fiscal measures to support households and businesses, alongside an increase in defense spending, are set to lift the average general government deficit to 5.3% of GDP in 2023-2024, more than double S&P’s previous forecast of 2.3%.

Shekel forecast: Bank of Israel attempting to cap downside for USDILS

Ehsan Khoman, head of EM research at MUFG, told Bloomberg that the Bank of Israel will likely be successful in capping the downside for the shekel:

“Given Bank of Israel rhetoric that signals the near-term policy focus is on efforts to stabilize the shekel, we view that it will prove successful in capping USD/ILS upside given ample FX reserves and likely low speculative long ILS positioning.”

To provide market liquidity prevent further shekel depreciation, the Israeli central bank announced a plan to sell up to $30 billion in foreign exchange reserves and said it would offer dollar liquidity to the market through SWAP mechanisms of as much as $15 billion. SWAP mechanisms are a type of futures contract where two parties exchange cash flows or liabilities from two distinct financial instruments.

Over the past month, the shekel has lost close to 6.3% of its value against the U.S. dollar and is down 15.75% so far in 2023.

At the time of writing, the USDILS rate held at 4.0808 (up 0.4% on the day), as per MarketWatch data.

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