"We're expecting an attack by speculators this year," says Excellence Investments Ltd. (TASE: EXCE) chief economist Yaniv Hevron, "unless the Bank of Israel changes its moderate tone." Colmex Israel CEO Yuval Tsabar adds, "It's not yet a shipwreck, but the big investors are starting to reenter the market."
The continually strengthening shekel (NIS 3.49/$ and NIS 3.97/€ as of last week) is unquestionably one of the most disturbing economic dramas around. Many parties are involved in the shekel exchange rates game: overseas investment banks, which are taking enormous positions; hedge funds that are distorting the market (some say for the short term, other say for longer); worried exporters who are trying to hedge their risk and reduce the enormous damage caused when they bring home cheap dollars and buy expensive shekels; delighted importers; important local businessmen joining the casino; small investors with sparkling eyes; speculators of all types; and of course the Bank of Israel, which sallies forth every so often and returns with dollars in order to moderate the shekel appreciation a bit, but which is being criticized in many quarters for its negligence and inadequate actions.
It is heaven for all sorts of speculators and gamblers buying and selling with high leverage. Every change of NIS 0.005 in the shekel exchange rate in the right direction puts a considerable amount of money into their pockets. Every so often, their footprints are visible in a rapid attack, and it remains anonymous in many other cases, because in the modern world of currency trading, it is difficult to know who is buying and who is selling, and whether it is being done as a hedge or a gamble; an act of caution, or wild speculation.
"It's a legal casino," says Protective Financial Consulting CEO Vered Yitzhaki. "Because of the leverage, the profits are enormous. Say you have $100,000. If you buy shares with it, you have to put all your money on those shares. Here, however, it's enough to put down 5-10%, so you can earn $1 million on $100,000."
What effect do the speculators have, other than some immediate fluctuation? You will not find agreement on this question; there is a large spectrum of opinions. Energy Finance Financial Risk Management owner and CEO Yossi Frank, for example, believes that concerns are manipulating the shekel, and says, "80% of the shekel appreciation over the past year is pure speculation and manipulation of the exchange rate, with no connection to economics. Were the shekel a security, they would have halted trading in it a long time ago, and would have arrested quite a few people." On the other hand, Tsabar, who has a trading room perspective and meets with sophisticated speculators among his clients, believes, "Speculators are riding the trend, not creating it."
The Bank of Israel, which regularly increases Israel's foreign currency reserves when the shekel strengthens as a result of an attack, and which will soon reach the limit of the reserves it recommended ($110 billion), also does not believe in a long-term or one-directional effect of speculators. On the other hand, it is very concerned about the phenomenon, and explicitly admits that "the shekel is too strong."
This concern is also expressed by Yitzhaki, some of whose clients are exporters suffering greatly from the situation. "The shekel today is one of the most desirable currencies in the world. It is also strong and attractive to investors, not just speculators," she says. "This is our main problem, and the exporters are very worried. Some of them tell me that they are considering measures such as layoffs and cost cutting. There are companies that are already barely keeping their heads above water, and some of them are even saying, 'If the shekel-dollar rate falls to NIS 3.30/$, we're shutting down.' When they ask me what's happening, where the exchange rate is going, I tell them to point their fingers at the Bank of Israel, and especially the Ministry of Finance, which has left the Bank of Israel to its own devices, and is doing almost nothing.
"The Ministry of Finance has to back up the Bank of Israel, and announce that even if the reserves exceed $110 billion, it doesn't matter," Yitzhaki declares. "The loss is only on paper. If the shekel-dollar rate goes up tomorrow, they'll make money, and the Bank of Israel will make money on the balances, because the dollar interest rate is higher than the shekel interest rate, and the money can be invested in all sorts of instruments. Were they to sit together and devise a plan, and were the market to see the Bank of Israel and the Ministry of Finance going hand in hand, it would show determination. Such a demonstration will send the speculators scurrying."
"Globes": What is the Bank of Israel doing wrong?
Yitzhaki: "I sat with them and told them that in my opinion, they have to be far more aggressive, not necessarily in their intervention, but also in visibility. If the Bank of Israel issues a statement that it will prevent the strengthening of the shekel at any cost, and shows determination, only that can affect this market, in which there is a strong effect of 'buying and selling on rumor.'
"It worked well in late 2008, when the shekel-dollar rate was NIS 3.20/$, and then-Governor of the Bank of Israel Stanley Fischer announced that the Bank of Israel would buy dollars every day. Within a few months, the exchange rate reached NIS 4.20/$, an even sharper rise than the one planned. Keep in mind, though, that Fisher was lucky then, because the dollar was strengthening all over the world."
The Bank of Israel does not have this determination now?
"No, the Bank of Israel isn't determined enough. It's hard for them to make an 'at any price' decision. In my opinion, the Bank of Israel is too cautious; it indicates a kind of weakness."
"Fairly symmetric activity"
"Our opinion is that the shekel is strengthening because of macroeconomic reasons, including the relatively good state of the economy and global reasons, such as the ultra-expansionary monetary policy prevailing worldwide," comments Amit Friedman senior advisor in the Bank of Israel Market Operations Department, which is responsible for implementing foreign currency and monetary policy. "This is causing excessive appreciation of the shekel, meaning a drop in the shekel exchange rate beyond the real factors."
What contribution are the speculators making to this?
Friedman: "As far as the question of whether the speculators are contributing to the trend – these claims have been made for many years, and we're following and assessing them. We're regularly in the foreign currency market, even when we don't intervene, through the process of determining the representative exchange rate, and we've also been intervening fairly continuously for over eight years, except for a two-year halt in the middle. We've purchased over $70 billion in recent years, and we're a fairly large player in the market."
Nevertheless, it is not enough, and it is being asserted that speculators are still managing to influence the shekel exchange rate, among other things through after-hours tradijng.
"The question is whether it is really possible to systematically influence the shekel exchange rate at times when liquidity is low, such as on Friday night. Our answer is that we see no systematic influence on the trend. Such activity is a possibility, but we find that it's fairly symmetric: there are nights with exceptional shekel appreciation, and nights with shekel depreciation."
You are in position to see better than others who these speculators are.
"Not every movement in the currency market is identifiable. The market is decentralized, and some of the deals are over-the-counter or on electronic platforms. Activity can sometimes be identified, such as hedge funds, whose activity is symmetric in both directions, incidentally. Sometimes, when they cause devaluation, people think it was done by the Bank of Israel."
Whether it is speculators manipulating the shekel or traders benefiting from the trend and ordinary business, the shekel is still too strong. What is the Bank of Israel doing about it?
"We completely agree with the diagnosis. The shekel is strong, and we are indeed very disturbed and worried about it, and we say this at every opportunity. We have already detected weakness in exports in recent years in comparison with the global market and growth in the domestic market. This is the reason why we're intervening."
The market says that you are intervening, but not enough. Why not set a floor for the basket of currencies, for example?
"Our policy is not to do that. A policy of protecting the exchange rate is unsuitable for a free market, and involves an increase in the foreign currency reserves beyond the Bank of Israel's control. Switzerland tried it in the past, and abandoned this policy. A flexible policy not committed to a specific exchange rate is better now."
But because you are close to the limit you set for the dollar reserves, it is liable to tempt speculators, who think you are constrained from responding.
"We've said several times before that the desirable level for the reserves is between $100 billion and $110 billion, but this refers to the desirable reserves as a reserve fund, and this level does not restrict the pace of buying the reserves when the aim is different, i.e. not the level of the reserves, but monetary policy. We have no problem about deviating from this amount if it's necessary."
It is known that you have occasionally said this, but the market may not believe you, and may think that you will find it difficult to do so.
"This message came up not long ago in a talk with one of the foreign banks. Everyone listens to it, but until we actually cross this line, there will be those who don't completely understand it. If and when we cross the $110 billion line, it will then be completely understood that we have no effective constraint."
What do you say to those who argue that if the Bank of Israel cannot prevent the shekel from strengthening, it is probably not determined enough, or is not taking the right measures?
"Monetary policy isn't infinite; it's limited. In this context, it's necessary to think about things more related to the long term, and that requires work with both the government and the business sector, so that our exports will continue to be competitive."
The market does not believe Trump
The saga of the strong shekel is indeed a compliment to the Israeli economy, with strong exports, relatively high growth for a developed country, low unemployment, and stability in banking and in general. It is also, and perhaps primarily, the story of the weak dollar. "No one in the world counted on such a drop in the dollar," says Hevron. "Since Trump took office as US president, everyone spoke about the strong dollar, and today, everyone's asking how it has weakened against all expectations."
What is the reason?
Hevron: "The main reason is that the markets believe that it will be very difficult for Trump to fulfill his promises, and he certainly won't manage to do it with the force he intended. It's true that the US Federal Reserve raised the interest rate, and that should strengthen the dollar, but everyone believes that it will be impossible to continue this. The strong shekel is first of all the dollar's story, but not only that."
What are the other reasons?
"The shekel has strengthened against all of the currencies, among other things because of very strong Israeli exports, which so far have been almost unaffected by the stronger shekel, although this will change at some point. Secondly, currency speculators regard the shekel as a strong place – a good place to park in, despite the low interest rate, and they are also looking at the Bank of Israel's foreign currency purchases, doing the arithmetic, and thinking how to take advantage of these market distortions."
"They remember that the Bank of Israel cited the figure of $110 billion, and has already reached over $107 billion, which means that when they near the boundary of $110 billion or more, there will be greater activity by speculators. The speculators think that a point is approaching at which it will be difficult for the Bank of Israel to buy dollars in order to moderate shekel appreciation. No one knows what this point is, but they see that it's approaching."
But the Bank of Israel is explicitly stating that this number does not constrain it.
"It's true that the Bank of Israel has changed its tune, and is saying, 'We can buy as many foreign currency reserves as we need, but it's not saying it clearly enough. It will have to be clearer on this point, and since the Bank of Israel is very far from raising the interest rate at the moment, as the year progresses, the speculators' activity will become significant, with the intention of strengthening the shekel, because they hold shekels and are speculating on the currency.
So the Bank of Israel has not changed its tune enough?
"No. It's not that it's not doing work, but when I compare it with other central banks, such as those in Japan, the US, and Europe, they're doing far more, and have been doing so for the past five years."
One person who is completely convinced of the great influence of speculators on the shekel exchange rate is Frank. He talks about the foreign investment banks taking positions in the shekel, and regards it as a key factor in the game.
What is the financial risk that they are taking in this gamble?
Frank: "You have to understand that beyond selling, they are very active in financial derivatives, such as options on the rate of a given currency against the dollar, and that's just one simple instrument. There are dozens of types of such financial instruments, so that they could be making huge profits without having to again buy the currency they sold, and even if they lose a little on the shekel, they have made a profit on the derivatives."
What is your opinion about the Bank of Israel in this matter?
"It has tried to deal with it over the years, but not in the right way, especially for the past two years. The shekel has strengthened by 30% over the past decade. Some of this is due to high tech and the natural gas discoveries, but of this 30%, 10% has been in the past two years."
What caused this jump?
"I live in this market, and I can tell you what has changed: the players realized that you can change the rules of the game, and the Bank of Israel has not realized it. They have realized that instead of going head-to-head against the Bank of Israel, they can work when liquidity is low. Instead of coming during morning trading hours, they come at night, or on weekends, when a sale of $10-20 million is enough to lower the shekel-dollar exchange rate by NIS 0.005/$ or more. On the Shavuot holiday, for example, the shekel dollar rate went down by NIS 0.03/$."
Could logical changes in the global and local economy be causing these fluctuations?
"I'll show you that it's not so. In March, within two days, two figures were published: one was very high, almost phenomenal quarterly growth of 6%, followed by the Mobileye(NYSE: MBLY) deal, which everyone thought would cause the conversion of a flood of dollars to shekels in order to pay tax on the deal. Then the dollar plunged 12% within three days, and the shekel strengthened.
"It sounds very logical, but three months later, within two days, two figures were published again: terrible growth figures for the second quarter - 1.4% (later revised downward to 1.2%), after which it was learned that the Ministry of Finance, the Bank of Israel, and the Israel Tax Authority had decided that taxes on the Mobileye deal would be in dollars. What happened? The dollar went down again, and the shekel strengthened. This game has no economic logic - only speculative logic."
What is the solution?
"There's an ideal solution, but the Bank of Israel is scared to death of it: putting a floor under the exchange rate against the basket of currencies, and anything sold that puts the price below the floor will be purchased by the Bank of Israel. I know that demagogues will say that it's asking for an attack on the currency (in order to take advantage of the opportunity to have everything anyone wishes to sell bought), but this doesn't exist now in the world, and the Bank of Israel can take the dollars it bought in the framework and investment in the US. That, by the way, should have been done when the shekel-dollar exchange rate was NIS 3.80/$, because at the current rate of NIS 3.49/$, even if it stays where it is, industry will not survive."
The Bank of Israel does not support such a floor. What else can be done?
"Another solution is to levy tax on speculative capital movements. Someone who buys shekels in order to invest in Israeli companies or real estate is welcome, but anyone playing with currency has to pay tax. Currency players hate taxes, and they certainly hate an active regulator, because who knows what else he can do, so they go to play somewhere else.
"The simplest thing that can be done is for the Bank of Israel to stop playing only according to its rules, and start playing with the speculators' tools. Let them go once on Friday at 3:00 PM and buy $1 billion. There will be a 5% devaluation in an hour, and the effect of such an extreme step will be so strong that many players will buy dollars, and the shekel devaluation will ignite by spontaneous combustion. The players who suffered such a major blow all at once will stay out of the game for a month or two."
A solution for one or two months is not a policy.
"There are also solutions for the longer term. The Bank of Israel has announced that all the revenue from natural gas in 2019-2029 will be put in a sovereign wealth fund for future generations. Why not do something similar with high tech, which is arousing great pride, but is also putting a lot of dollars into the economy> Announce a sovereign wealth fund on a different format that will fund infrastructure projects, for example."
"The customer knows what he's getting"
Tsabar provides another glimpse at the identities of the speculators making a living from NIS 0.005 differences in the exchange rate. He says, "There are speculators here who know far more than I ever will - very smart people with deep academic backgrounds in macro and microeconomics. They're doing research, and getting into the thick of things."
"Our clients, mainly the speculators among them, know and understand what the risk is. Someone who has NIS 1 million and allots NIS 50,000 for investment understands the risks being taken in order to achieve a better return. It may surprise you that their profit statistics are very different from the casino that this type of trading is reputed to be. The websites of some of the trading websites display the ratio of clients making money to those losing money."
The prevailing image is very different.
"It's true that it used to be that way, and the forex world then had a justifiably negative image. Since then, however, both in Israel and worldwide, regulatory changes have occurred that have driven all the concerns that did not operate properly out of the market. Regulatory supervision is very close, and the Securities Authority is the strongest regulator, with the sharpest teeth. It has become a world in which the client really knows what he's getting."
What proportion of the market consists of speculators?
"No number can be accurate. No one knows."
Published by Globes [online], Israel Business News - www.globes-online.com - on July 9, 2017
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