On the freeze over forex

1. The forex market has calmed down, for the moment. After the dollar peaked at NIS 5, the latest interest rate hike managed not only to stabilize the market, but even to press the dollar down beyond expectations. Heavy selling by foreign banks weakened the dollar below NIS 4.80, and there it stayed. Last week the dollar fluctuated within a narrow band, and activity in the spot market and options and swap arena dwindled.

2. Klein's speech didn't affect the market. On Friday the dollar jumped by about 0.6%, and some dealers hastened to explain that his aggressive words, at the Israel Democracy Institute's annual economics "Caesarea conference", were responsible, because he'd reopened his battle with Finance Minister Silvan Shalom.

But the real reason behind the dollar's climb on Thursday and Friday was that the banks found themselves short on the dollar. After heavy selling of dollars earlier in the week, a major forex buyer suddenly showed up forcing the banks to buy dollars from one another, which quickly kicked up the exchange rate.

The one that set off the buying spree was Bank Leumi, which hurried to cover its short position by buying from its fellow banks a phenomenon known as a short squeeze.

In practice, the thrust of the governor's speech hadn't been his relations with the finance minister. Sure, the headlines focused on the resumed tensions, after the governor bluntly blamed the financial crisis on the government's mismanagement of its budget and deficit, and defaulting on its commitments made in December 2001.

But Klein also clearly stated that the job of maintaining financial stability is his, and said that he will do his job.

Translated into deeds, Klein was stating that he would not rely on the government any more, but would act by lifting interest rates every time the dollar raised its head.

If anything, his statement supports the shekel. The dollar's droop yesterday, in options trade, to NIS 4.79 attests that Klein's speech did not change the trend.

3. There are surplus shekels floating around. Last week currency dealers reported something unusual: accrual of major surplus shekels in the banking system, to the tune of billions, which the banks are desperately trying to put in investment vehicles. The source of the shekels is heavy selling by the public, mainly of holdings in forex-based mutuals, and diverting the money to short-term shekel daily and weekly deposits.

The result of the surplus shekels is evident in the rising prices of short-term makam certificates, which traded yesterday at yields of 8.8% for the month series, which is below the central bank interest rate of 9.1%. But, unlike a month ago, when rising yields reflected mainly expectations of a rate rise, the current yield levels do not indicate expectation of a rate drop they are the result of a momentary surplus demand for a specific vehicle.

4. Betting against the shekel has become expensive. Even though many players continue to believe that in the long and medium run, the shekel is not done weakening, Klein's rate hike made betting against the shekel very pricey. At the current interest rate gap, the meaning of speculating against the shekel meaning, taking credit in shekels and using it to buy dollars is 3.5 agorot a month on each dollar. In that situation, each business day the shekel does not weaken the speculator loses a tenth of an agora.

Many of the foreign banks don't want the cost, which, many think, is why they were the chief sellers in the last couple of weeks.

5. Business-people are trying to restore their forex loans, but the banks are in no hurry to comply. Many claim that at the current rate of interest on the shekel, business is paralyzed - can't invest or buy assets, because there are no assets in Israel with growth potential or yields of 15% a year.

What to do? Some businessmen are asking the banks for dollar loans lasting 2 to 5 years, but the banks are shaking their heads, being short of foreign currency credit lines themselves. Anybody who does have good collateral does, however, find that the rates the banks demand beyond Libor are high 2% to 3%, according to the quality of the borrower, and the specific bank. Forex players and businessmen report that Leumi is in the best condition of all Israel's banks, from the perspective of access to foreign currency resources, maybe thanks to the massive deposits it holds for foreign residents.

6. The balance of forex is still biased toward leaving the country. In the last week, more and more businesspeople claim that the shekel's direction is up, and that it will stabilize at NIS 4.5 to NIS 4.6. But experts in the dealing rooms think otherwise, that the devaluation will resume.

They say that the Bank of Israel's moves did stabilize the forex market. But the bank didn't convince anybody, here or abroad, to resume investing in Israel.

The movement of capital is still outwards, the dealers say: therefore the pressure on the shekel will persist in the medium run, mainly if and when the terrorism picks up its head again.