The yield premium investors demand to hold Israeli bonds over U.S. Treasuries, already the narrowest in more than seven years, is set to shrink further amid prospects for deeper interest-rate cuts.
The gap between Israel’s 10-year debt and similar-maturity Treasuries may fall to 50 basis points in coming months, according to Ori Greenfeld, an economist at Tel Aviv-based Psagot Investment House Ltd., from 70 basis points today, the least since February 2006, data compiled by Bloomberg show. The spread contracted 154 basis points this year, the data show.
Speculation that the central bank will keep cutting borrowing costs, after three reductions this year, to spur economic growth and weaken the shekel will keep Israel’s bonds outperforming Treasuries. U.S. 10-year yields have jumped 106 basis points in 2013 as the Federal Reserve prepares to start tapering its monetary stimulus.
“The Bank of Israel’s policy is expected to be expansionary for another few months, while the Fed policy is expected to tighten,” Greenfeld at Psagot, which manages the equivalent of $51 billion, said by phone on Dec. 5. “Long-term local bonds look attractive and provide a safety cushion.”
Fitch Ratings raised the nation’s credit outlook to positive from stable on Nov. 29, citing the shrinking fiscal deficit and reduced risk of military conflict with Iran. Five-year credit-default swaps on Israel, used to insure against non-repayment of debt, fell to 102 basis points last month, from a 10-month high in September.
Six-month interest rate swaps, used to speculate on borrowing costs over the period, were at 0.88 percent by 5:53 p.m. in Tel Aviv, below the Bank of Israel’s benchmark 1 percent lending rate.
The shekel has strengthened 6.9 percent this year, the most among 31 major currencies tracked by Bloomberg. That’s making exports less competitive. Shipments abroad, which account for 34 percent of Israel’s gross domestic product, fell 16 percent in the three months to September, according to the Jerusalem-based Central Bureau of Statistics.
“The central bank might have to turn to monetary policy action to try to weaken the currency,” Benoit Anne, the head of emerging-market strategy at Societe Generale SA in London, said by phone Dec. 5.
Economic growth will rise to 3.5 percent this year, before slowing to 3.4 percent in each of the next two years, according to median estimates of economists on Bloomberg.
The euro area’s gross domestic product will expand 1 percent next year after two years of contraction, according to 47 economist forecasts compiled by Bloomberg. At the same time, the U.S., the world’s biggest economy, is projected to grow 2.6 percent and Japan, the third-largest, will increase 1.5 percent.
“For the spread to narrow further we would need to see more optimism about global growth,” Rafi Gozlan, chief economist at Tel Aviv-based I.B.I.-Israel Brokerage and Investments Ltd., said by phone Dec. 5. “The chance that the spread will widen in the coming year is higher than the opposite.”
The number of economists predicting the Fed will slow bond purchases as early as this month has doubled from early November. About a third of those surveyed by Bloomberg last week said policy makers will start the tapering at their Dec. 17-18 meeting. A quarter of the economists said the Fed will act at its Jan. 28-29 meeting while 40 percent don’t see a reduction until the March 18-19 meeting.
“The Israeli bond market is a safe haven market,” said Societe Generale’s Anne. “If we assume that tapering in the U.S. will start sometime early next year that will create a risk-aversion shock thereby triggering outperformance of the Israeli market.”