The Options Trend Telling Flug Not to Get Used to Falling Shekel

  • Israeli currency falls 3 percent in May, ends winning streak
  • Forwards, options and history show shekel will probably rise

Israel’s shekel may have just posted its first monthly loss since January, but all the signs are that the retreat will be short-lived.

Options traders are the least bearish on the currency in more than five years, while forwards show the shekel strengthening in 12 months’ time, according to data compiled by Bloomberg. Even history indicates more gains may be in store, with the shekel appreciating in June for the past three years.

A rebound will put further pressure on Israel’s central bank as it seeks to revive a $296 billion economy of which exports account for about a third. Policy makers led by Governor Karnit Flug have cut the nation’s key interest rate to a record low 0.10 percent and extended a program of dollar purchases to stem gains in the Israeli currency spurred by gas-exploration developments and foreign investment in the technology sector.

“The Bank of Israel is clearly concerned about the weakness in exports, but there is not much they can do about it,” said Michele Crema, a Herzliya, Israel-based analyst at UBS Wealth Management, a business division of the world’s third-biggest foreign-exchange trader, who sees the currency weakening to 3.90 per dollar in the next three months before recovering to 3.70 in a year.

The shekel fell 3 percent in May, ending a three-month streak of gains that was the longest sequence of advances in two years. The drop was spurred by a slowdown in first-quarter economic growth, which at 0.8 percent was almost 2 percentage points below analyst forecasts.

It’s the seventh consecutive year the currency has retreated in May. On Wednesday, the shekel weakened 0.1 percent to 3.8547 per dollar at 2:52 p.m. in Tel Aviv.

Forwards Drop

One-month risk reversals -- a gauge of investor sentiment in the options market -- fell to a 2011 low of 0.25 percent in April and have since remained unchanged, Bloomberg data show. Meanwhile, 12-month forwards declined 50 points last month to 470 points below zero, which translates to a 1.2 percent advance over the period. The contracts are 10 points away from the lowest level since 2007.

Natural-gas production has increased the country’s current-account surplus. For every $1 billion improvement, the shekel appreciates about 1 percent, the Bank of Israel estimates. In 2013, policy makers resumed a foreign-exchange purchase plan to offset the shekel’s gains. This year, they plan to purchase $1.8 billion.

“Negative interest rates wouldn’t be a game changer for the shekel, so policy makers will rely instead on forward guidance and discretionary foreign-exchange interventions to ease shekel appreciation,” Crema said.

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