Escalating Israel-Hezbollah Tensions Trigger Surge in Israeli Government Bond Yields

By Aryeh Stern

The escalating confrontation between Israel and Hezbollah in Lebanon has heightened concerns among investors, driving up yields on Israeli government bonds. Over the past few days, the yield to redemption on long-term government bonds has surged, reflecting the increased perceived risk of Israel’s debt.

Currently, the yield to redemption on shekel-denominated 10-year government bonds stands at 5.2%, the highest in 13 years, and represents an increase of more than 0.5% in just two weeks. A year ago, the yield on these bonds was 3.8%. Similarly, the yield on 30-year shekel-denominated government bonds has risen to 5.7%, compared to 4.1% a year ago.

This spike in yields results from a decline in bond prices. So far this year, the prices of 10-year shekel bonds have dropped by 4.8%, while those of 30-year shekel bonds have fallen by 13%. This decline is partly due to the substantial increase in the Israeli government’s debt-raising activities to cover war expenses. For instance, in July, the government plans to raise NIS 17.5 billion, double the amount raised in the months before the war.

The rise in yields means that the government will have to offer higher interest rates to attract investors to new bond issues. This situation is exacerbated by Israel’s downgraded credit rating. In April, S&P lowered Israel’s sovereign rating from to A+ AA-. In practice, dollar-denominated Israeli government bonds are being priced as if the country’s rating were much lower, between BBB- and BB+.

Another factor contributing to the decline in Israeli government bond prices is the sell-off by foreign investors since the war began. Modi Shafrir, chief financial markets strategist at Bank Hapoalim, notes that since September 2023, foreign investors have reduced their holdings of Israeli government debt by NIS 23.5 billion, which represents 5% of their total holdings.

For comparison, the yield on 10-year U.S. Treasury bonds, considered a benchmark, currently stands at 4.46%, up from 4.2% in the past two weeks.

Israel’s risk premium, as reflected in the 10-year CDS (credit default swap) price, has also risen sharply. The CDS price is now 176 basis points, an 11-year peak, indicating increased fear among foreign investors of a serious conflict on Israel’s northern border. In contrast, before the outbreak of war in October 2023, the CDS price was about 80 basis points.

Additionally, in recent weeks, several countries have advised their citizens in Lebanon to leave, further underscoring the growing regional instability.