Israeli Economic Analysis and Market Insights by Alex Zabrzynski, Chief Economist of Meitav

2024-01-29 08:24:49

| Alex Zabrzynski, the chief economist of Meitav |

JSharel: the shekel disengaged from the war

Despite the increase in Israel’s risk premium (CDS) in the last two weeks, it actually got stronger. Its strengthening is well-aligned with gains in US stocks as it was until the end of 2022, before it was disrupted by legal reform.

If we apply the relationship between the change in the index and the exchange rate of the shekel, as it was until the end of 2022, from the beginning of the war in October, the theoretical exchange rate was supposed to be today at a level of about 3.75 shekels per dollar, very close to 3.69 in practice.

Seemingly, there is no expression here of the impact of the war.

In our estimation, the strength of the shekel stems from the record exposure to foreign exchange by the various investors. As a result, there are not enough players in the local market who wish to further increase their exposure to foreign exchange, unless the circumstances change for the worse.

We note that according to the turnover of foreign exchange in the banking system in Israel, local investors greatly increased their activity in foreign exchange, while the turnover of foreigners actually decreased sharply.

| Canceling earmarked bonds saved the markets in Israel

Relative to the events in Israel in the last year, which included the legal reform and the war, the performance of the local channels was not so bad, in particular the bonds and especially the corporations. The situation would probably have been much worse if the government had not stopped issuing designated bonds in October 2022.

Based on the clear connection between the performance of the stock markets and designated bond issuances in the previous years, it can be estimated that the increases in stocks in Israel and abroad in 2023 would have led to issuances of approximately NIS 30 billion in designated bonds if they were not canceled.

Instead of receiving designated bonds, the eligible pension bodies are now supposed to invest the amount of eligibility according to the composition of their general portfolio, with approximately 60% of the free funds (outside of designated bonds) of the new and old pension funds combined being invested in the local market. We will add that the redemption of approximately NIS 10 billion of designated bonds in 2023 was also added to the eligibility amount.

You can see the segmentation of the net investments in the last 12 months of the entities that are not eligible for designated bonds, such as the training and provident funds and the trust funds (without the financial ones), compared to the pension funds that are eligible for the designated bonds. The differences in the size of the investment in the local market between those eligible and not eligible for designated bonds are huge:

• In the last 12 months, the entities that are not eligible for designation have sold investments in Israel for approximately NIS 50 billion (22 billion by the training and provident funds and 28 billion by the trust funds). On the other hand, they spent more than 40 billion shekels on investments abroad (31 through the training and social security benefits and about 10 billion through the trust funds).

• In contrast, the pension funds (the old and the new together) invested only about NIS 4 billion abroad compared to more than NIS 40 billion in Israel. The pension funds’ net investments in Israel included stock purchases of about NIS 2.3 billion, marketable government bonds of about – NIS 15 billion, corporate bonds of approximately NIS 12 billion and other investments, including deposits, of approximately NIS 12 billion.

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• The amount of liquid assets in the economy has increased significantly since the beginning of the war. There was an increase of about NIS 50 billion compared to the trend in the current account balances in the banks and about NIS 40 billion in the deposit balance up to one year. The figures include both households and companies. At the end of the war, the excess liquidity may help the recovery.

• The supply of credit in the economy decreased. The balance of credit to the business sector has hardly increased in recent months after a very rapid increase since the beginning of the corona virus. Credit to households, excluding mortgages, is on a downward trend, especially credit from non-bank borrowers. A decrease in credit supply is another reason why the Bank of Israel is supposed to lower interest rates in the economy.

• of the Bank of Israel rose in December after three consecutive months of decline. We note that the total export of high-tech services increased in November following the trend of improvement in the previous months.

| pestleYat Food prices do not depend on economic forces

It does not seem that the price increases announced by the food companies are due to the increase in their costs:

• First, the food price index, including fruits and vegetables, rose last year in Israel by 5.9%, the highest among developed countries except England.

• The price index of agricultural goods in the world actually decreased by 13% in the last six months, when the prices of most goods decreased. Even if the price changes are translated into shekel terms, it is still a decrease in the price index of agricultural goods.

• Over the years there has been a close connection in Israel between the index of inputs in the agricultural sector and food prices in the supermarket. The index of inputs in the agriculture sector decreased by 1% in the last year. The output price index of the food industry, the prices at which the goods are sold to the marketing chains, which also affects the food prices for the consumer, is also in a moderating trend.

• Recently, there has been a sharp decrease in the total revenue of the agriculture sector. The decline began even before the war and intensified during it. In the past, a change in the rate of growth in the revenue of the agriculture sector led to a similar change in the prices of fruits and vegetables with a delay of about a year. It is possible that this time the decrease in sales is more related to the lack of agricultural products and not to the decrease in demand due to the expensive prices. Still, eventually, when supply improves, prices should come down. It may just take longer this time.

| world: Despite the high interest rate, growth in the US realso And even MayTza

After a growth of 4.9% in the third quarter, the fourth quarter was also recorded in the USA of 3.3%, significantly higher than forecasts. In total, the economy grew in 2023 by 2.5%, compared to 1.9% in 2022. Looking at the last 4 quarters, its contribution to the growth of private consumption has been increasing, despite the high interest rate. There has also been an improvement in the contribution of investment in residential and non-residential construction.

The rapid increase in is due to the strong increase in the real incomes of the households which grew in the fourth quarter by 4.2% compared to last year compared to the average rate of about 3.3% in the years before the epidemic. After a lull, the consumption of products accelerated again, while the consumption of services is growing at a steady rate.

The other economic data in the US were also quite positive overall:

• Home sales, both new and second hand (Pending) were higher than forecasts.

• Purchases of investment products by companies have returned to increase after a slowdown.

• The manufacturing index (PMI) rose above 50, contrary to the forecast for a decrease to 47.6. The index in the services sector also rose above the forecast.

| Good news also on the inflation front

Also on the inflation side, the data in the US is surprisingly good:

• PCE inflation remained at 2.6%, core fell to 2.9% from 3.2%, lower than forecast. Based on the monthly changes in the six-month core measures (in annual terms), the annual rate of change of PCE Core will reach the Fed’s target of 2% in March 2024 with about a 90% chance.

• Business expectations in the Fed survey returned to almost 2%. This is an important survey because in it the businesses give a forecast of the change in the expected price of a product or service they sell, about which they have a lot of information and a great deal of control.

• According to the index that checks the expected changes in rental prices based on the private surveys published by the Fed branch in Cleveland, a sharp decrease in the housing section of the price index is expected in the coming months.

| What to expect from the Fed?

Ahead of the Fed meeting this week, the mystery is sharpening – how does the higher rate fail to cool the economy, but inflation still goes down?

It is possible that the cooling in growth is still on the way. However, the data give the impression that the economy is actually strengthening.

What is the required interest rate if the “dream” scenario is realized in which the economy does not weaken, but inflation returns to the target?

The central bank’s task gets even more complicated because in addition to the economic mystery, the financial markets are also bubbling. The S&P 500 is trading at a forward earnings multiple of nearly 23 compared to the historical average of about 18.5. Even the multiplier of the equally weighted index is higher than the historical average.

According to the historical trend of the relationship between growth and the Fed interest rate since 1985 (without the years of zero interest rates between 2009 and 2015, two years of the Corona and the peak period of the crisis in 2008/09) the interest rate that corresponds to the current growth rate (3.1% YoY) is in the range of 4%- 5%, not far from the current interest rate.

In fact, the question that the Fed has to deal with is not only when inflation will drop to a level that will allow it to lower interest rates, but what is the equilibrium interest rate appropriate for the given economic situation if growth does not weaken significantly. The answer may lead to the conclusion that the overall scope for lowering interest rates is more limited than the existing forecasts of the central bank.

The Fed may have to raise its forecast in the next update in March for the longer run interest rate from the current level of 2.5% to much higher levels. We note that in 2012, when he just started publishing his DOTS, the expected longer run interest rate was 4.25%. Under these circumstances, he is not expected to preempt the interest rate cut, despite the drop in inflation.

By the way, the market is already there. According to the interest rate contracts, investors already today think that the Fed interest rate in the long term (beyond 2026) will be at a level close to 4%.

| God-ECB and theBOJ

• The ECB seems to have failed to convey a message last week. On the one hand, the governor said that the bank would not rush to lower the On the other hand, she stated that the risk of downward growth is decreasing and the rate of wage increase is moderating.

• The markets are optimistic about the interest rate cut soon. The interest rate path embodied in the contracts reflects that within a year the interest rate in Europe will drop by 2%. This means that starting with the next meeting in March, the interest rate will decrease at each meeting by 0.25%. Seems a little too optimistic.

In Japan, the governor’s hawkish statement last week once again increased expectations for the rise of the However, the price index in Tokyo on Friday, which is intended to accurately describe inflation in Japan as a whole, sharply lowered the annual rate of inflation.

This development reduces the chance of an increase in interest rates in Japan.

The writer is Chief Economist of Meitav Investment House. This analysis is intended for the purpose of providing information only, and in no way should it be considered an opinion, proposal, recommendation or consulting/marketing for the purchase and/or possession and/or sale of securities and/or the financial assets described therein. The information contained in this review does not claim to contain all the information needed by a potential investor and does not claim to be a complete analysis of all the facts and details contained therein. This review is not a substitute for investment advice/marketing that takes into account each person’s data and special needs. Meitav Dash Brokerage, sister companies and other companies in the Meitav Dash Investments Ltd. group and/or interested parties to any of the companies listed above and their customers, may have an interest in the securities and/or financial assets included in this review.