The Israeli capital market has been closely mirroring the geopolitical developments on its northern border, offering a unique lens into the financial market’s sensitivity to regional tensions. A recent Hezbollah attack on six Israeli civilians triggered a 1.7% drop in the Tel Aviv stock market and a surge in government bond yields. However, as the week unfolded, these concerns gradually eased, with the market recovering losses, highlighting the market’s acute responsiveness to the evolving situation.

Market volatility since the war’s onset

The onset of the conflict ushered in a period of heightened volatility in the Israeli capital market. In the first three weeks of the war, the Tel Aviv 35 index plummeted by 12%. Notably, a significant shift occurred on October 26, gaining momentum after Hezbollah leader Hassan Nasrallah’s measured speech on November 3, interpreted by investors as a sign of reluctance to escalate the conflict. Subsequently, the Israeli stock exchange recovered about half of its initial losses, indicating the market’s sensitivity to the Northern front’s potential impact.

Therefore, analysts and financial institutions are basing their economic recovery forecasts on the assumption that the conflict will primarily focus on Gaza, with limited intensity in the north. The Bank of Israel’s optimistic forecast predicts positive growth for both 2023 and 2024, with a low deficit. Similarly, rating agencies such as S&P foresee a gradual economic recovery, contingent on the war remaining concentrated in Gaza.

The broad market consensus currently leans towards an optimistic scenario as well, assuming that the conflict will stay confined to Gaza. The rationale behind this optimism lies in the potential consequences of an expanded conflict, which could lead to a downgrade of Israel’s credit rating and a significant weakening of the shekel against the dollar.

Impact on foreign exchange and stock markets

The foreign exchange market has experienced significant volatility during the conflict. While the dollar initially surged to a 16-year high against the shekel, recent stability can be attributed to various factors, including the lack of northern expansion, positive trends in global stock markets, and the intervention of the Bank of Israel.

Should the conflict escalate to the north, experts anticipate an increase in Israel’s risk premium, potentially leading to a sharp decline in financial markets. The shekel could weaken, and the market might underperform. However, opinions diverge on the overall impact, with some suggesting that an expanded conflict could strengthen the local market.

Amir Kahanovich, deputy CEO and chief economist at Profit Financial Services, argues that an expanded conflict in the north might paradoxically boost markets. He suggests that the market, being aware of the potential for a northern front, has already factored in risk premiums. Moreover, the economic rebound post-war, accompanied by increased government spending and monetary easing, could support market growth. Kahanovich also highlights the historical precedence, such as the Second Lebanon War, that saw a rapid market recovery within a month. He dismisses concerns about an imminent collapse of the market and the shekel during a northern conflict, particularly in the medium term, once the initial panic subsides.

In conclusion, the Israeli capital market’s response to the ongoing conflict reflects its acute sensitivity to geopolitical developments. While the prevailing optimism hinges on a scenario where the war remains focused on Gaza, the potential for a northern expansion introduces uncertainty. Needless to say, but investors will have to navigate this intricate landscape, considering the complex interplay between geopolitical events and market dynamics in the near term.

Main article image: Lebanese side of the border between Israel and Lebanon after an Israeli airstrike, November 18, 2023. REUTERS/Evelyn Hockstein