Too far, too fast
“There is now, finally and very belatedly, a broad consensus among economists and analysts of the Israeli economy, both in Israel and abroad, that the Israeli shekel is overvalued.”
That was the opening of a Global Agenda column in late January of 2014. The consensus referred to continued to broaden over the following months, in tandem with the ongoing rise in value of the shekel, a trend which continued remorselessly through the first half of the year and into July. Even the Bank of Israel had abandoned any pretense that what was happening was transient or insignificant and was speaking openly of the ‘overvalued shekel’ as a negative and undesirable phenomenon.
The foreign currency market, however, paid no attention to the wise men (and women) at the central bank and elsewhere. That month — July — the shekel/dollar rate hit 3.40 and, despite the general agreement that the Israeli currency was far too strong and was posing a growing threat to the well-being of exporting firms – the backbone of the economy – there was also general agreement among traders that the trend would extend further. People spoke of 3.30 to the dollar and even 3.20 – the level at which, back in 2008, the Bank of Israel had unleashed a large-scale, ongoing intervention that had turned the tide back then.
This time, however, there was no question of unleashing anything. The Bank of Israel was already intervening on a large scale, but to no avail. The market swallowed all the shekels that the central bank offered for sale – and much more besides. But the new team in charge at the Bank, led by Karnit Flug and Andrew Abir, were unflustered. The trend would change, they maintained – and looked overseas for their salvation.
They proved right on both counts. The trend of the shekel changed, mainly because the global trend changed. The dollar had stopped going down against the euro and the other European currencies back in May, but the shekel was so set in its rising ways that it paid no attention until, in July, it tried and failed three times to get beyond that 3.40 level. This development, a classic “triple top” in the jargon of technical analysts, was a clear signal that the trend had exhausted itself.
Nevertheless, even among those who were convinced that the shekel was overvalued, there were surely very few – if any – who believed on August 1 that by year-end – in fact before mid-December – the shekel would have fallen as far as four to the dollar. Yet that is what happened.
True, this decline in value (people speak of the shekel ‘going up’, but that refers to the rate: 4.00 is ‘higher’ than 3.80, but it represents a lower value) was assisted by the Bank of Israel, which continued intervening on the way down. In fact, the central bank under Karnit Flug displayed considerable tactical acumen during the critical early weeks of the shekel’s decline. Every time it seemed that the move had run out of steam, Abir’s traders entered the market and gave it a further push down the slope. That ensured that those holding “short” dollar positions – meaning that they were betting, usually with borrowed money, that the dollar would go down against the shekel – were unable to regain the initiative and were eventually forced to “cover their shorts” by buying dollars, thereby helping push the dollar higher and the shekel lower.
That ‘technical’ consideration, that people who had been betting on the shekel’s continued rise ended up being forced not merely to fold, but to move to the other side, is the best – perhaps the only – explanation of why the shekel moved so far, so fast. The decline from 3.40 to 4.0 to the dollar took a fraction of the time that the shekel had needed to make that climb. It was yet another example of the adage that ‘the market goes up on an escalator and down in an elevator’.
The story of the shekel serves to illustrate the vastly larger story playing out on the global scene over the same time-frame. In May, the world and his mother were long the euro and short the dollar. That trend exhausted itself at 1.40 dollars to the euro and 1.73 dollars to the pound. Slowly at first, but with increasing speed, the dollar rose and the European currencies sank. The fundamental reasons – if you believe in economic fundamentals – are quite secondary to the speed of the move, which in recent days has taken the dollar to 1.17 and 1.50 to the euro and pound respectively. These are levels that were unimaginable a few weeks ago, yet here we are…
But the wheel has come full circle, at least in the technical sense. The sentiment indices – compiled by asking traders and advisers on a daily and weekly basis whether they are bullish or bearish on the dollar, euro or whatever – are now at even more extreme positions in favor of the dollar than they were positioned against it in May.
That is as near certain a signal as you can get that the trend in force has run its course and is about to change direction. Everyone is on one side of the same trade and, when for any reason it moves in the direction that everyone bet against, then ‘everyone’ will have to run for cover. The euro et all will rebound, taking the shekel with them on the way up. That move may be short and sharp, or long and slow, but it is now overdue.
Originally published on January 9th, 2015.