Twin reversal

Two separate developments occurred this week that signal fundamental changes of trend in the foreign exchange markets. One was local and saw the shekel finally reverse course and fall against all the major global currencies, after a period of prolonged strength that took its value versus the US dollar to a level not seen since 1997. The other was global, and signalled the end of the six-year decline in the value of the US currency against all the other important currencies. In neither case is there any guarantee whatsoever that the latest developments really do presage definite reversals. But in both cases, there is good reason to believe they do.

Let’s begin at home. Last week’s column highlighted the ‘Supershekel’ phenomenon, just in time to catch its peak. The length and intensity of the period of shekel strength may be measured in various ways. In one sense it began in mid-2002, when a severe financial crisis in Israel sent the shekel’s value plummeting to 5 to the dollar. Although this remains the all-time low for the shekel’s value, it was approached several times in subsequent years, most recently in July 2006, after the outbreak of the Second Lebanon War, when it touched 4.75 to the dollar. From there to last week’s peak (in value) of 3.23 in less than two years is surely a remarkable rise. Yet last year’s low-point for the shekel, of 4.33 in late July, is also a valid starting-point: a 25% rise in value in ten months or so is extraordinary by any standards, and unprecedented in Israel. Finally, in the last several months, the shekel rose sharply not just against the dollar but against the euro as well, to a peak of 5 shekels to the euro.

This rise had many proximate causes, but it resulted in a gross over-valuation of the Israeli currency. The Bank of Israel tried to stop the shekel’s rise by intervening directly in March, but the impact proved short-lived and the central bank had no stomach for a prolonged campaign. This week, however, the Israeli Treasury entered the fray, buying large amounts of dollars for its own purposes – namely to repay foreign loans at bargain prices, from its point of view. This, coupled with strong hints from the Bank of Israel that it might intervene again, provided the strongest possible signal to both domestic and foreign players in the shekel market that the one-way street was now open to traffic in both directions, and probably encouraged many participants to stop buying shekels and consider ‘going long dollars’ (ie selling shekels and buying dollars).

 The result was a rise of some 4-5% in the shekel’s value versus the dollar and other currencies between last Friday and yesterday. Whilst not a certainty, there are many good reasons to think that this is the end of the strong shekel for quite some time. One of them is that, quite coincidentally, a sea-change in global sentiment toward the dollar has taken place in the last few days. This development actually began some time ago: many analysts suggested in late 2007 that the dollar’s prolonged devaluation was likely to end this year, although the US-centred financial crisis in the first part of the year actually sent the dollar to new lows against the euro and other currencies. But the most recent meeting of the G7 countries (US, Canada, UK, France, Germany, Italy and Japan) ended with a communiqué effectively announcing that European governments were fed up with a process in which the dollar fell against European currencies, making life harder for them and easier for the Americans. That suggested that the end of the six-year dollar downtrend was in sight, but the whistle for full-time really blew this week.

 It was Fed chairman Ben Bernanke who, in back-to-back speeches on Tuesday and Wednesday made crystal clear that the policy of ‘benign neglect’ of the dollar was over. The reason, he explained, was not that the US has decided to be nice to the Europeans, but that the cost of the weak dollar, in terms of driving up commodity prices and fuelling inflation, was now much greater than the benefit in terms of trade competitiveness. American self-interest demanded a change – so a change there will be. It is unlikely to take the form of an immediate rapid rise in the dollar’s exchange rate, but it is very likely that six and twelve months hence the dollar will be significantly higher against the euro et al. Yea, even against the mighty shekel.

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