Algo Funds Seen as Culprit in Overvalued Shekel

“We have identified operations by players that aren’t actually linked to real operations and these are traders with models and we have intervened within this context,” said Governor of the Bank of Israel Karnit Flug.

The cryptic criticism was aimed at the so-called algo funds, which have played an increasingly significant role in Israel’s foreign currency market and have been identified as being partially to blame for the stubborn strength of the shekel against the dollar.

“We know an attack when we see one,” Globes said, quoting “market players,” who say that the current wave of dollar selling started the moment the shekel-dollar rate fell below NIS 3.50/$.

The “players” Flug so obliquely referred to are algorithm, or algo, funds. The field has expanded rapidly in recent years, and many large global investors, such as George Soros or Goldman Sachs, have added an algo fund to their arsenal.

“The scope of the algo players in the past few days has been huge,” they say, “billions just in the past two weeks. With amounts like these, a one-time purchase of a few hundred million dollars wasn’t serious. To have an impact on the market, you have to intervene at a rate of $500 million a day.”

The scale of the Bank of Israel’s current intervention has not yet been disclosed, but it’s estimated that on one recent trading day it bought hundreds of millions of dollars.

Analysts say there is reason for optimism about reining in the algo funds’ impact on the exchange rate, which is particularly worrying for export firms.

“You need to understand what motivates the algo players. These are not bad people and it’s not some kind of conspiracy against Israel, but a fairly simple investment strategy. If your opponent is a foreign hedge fund or financial institution that believes in Israel and makes a strategic decision to enter the market, you’ll find it hard to counter him. Intervention in shekel trading will not be effective, and will only encourage him, because it will help him buy shekels more cheaply,” explained one analyst.

“But if your opponent is an algo fund, all you have to do is to demonstrate that the momentum has stopped. It’s enough for the shekel-dollar rate to stay at, say, NIS 3.40 for a few days and then start to rise for the model to reverse direction. It really makes no difference to the algo player if he buys dollars and sells shekels, or the other way around. All he needs is to see that the momentum has changed.”

Another cause for optimism is that when the rate has dipped below NIS 3.40 in the past, the dollar soon regained weight against the shekel, bringing the exchange rate back up to a level more commensurate with its true value.

However, there are experts who take a gloomier view.

While Alex Zabezhinsky, chief economist at Meitav Dash investment house, agrees that “there’s something excessive in the shekel’s strength. The Israeli currency should be strong but it’s too much,” he does not think it will be easy to change.

“I don’t think the Bank of Israel can do something special to change the rate,” Zabezhinsky told The Jerusalem Post.

“One of the mistakes of the BOI was three years ago, when it cut the interest rate to zero percent. Because, from zero, you cannot cut more. And if there are currency speculators, they know that the Bank has no real options.”

The exchange rate may see a correction only after that Israeli economy weakens due to a decline in exports, Zabezhinsky said, with geopolitical trends or U.S. policies helping things along.