FX & Y: The shekel paradox

The factors driving Israel's currency higher may owe less to Jerusalem than to Silicon Valley

The Israeli shekel's surge to a 33-year high against the dollar—breaching the psychologically significant threshold of three to the greenback for the first time since 1993—is one of the stranger puzzles in global currency markets. Up roughly 24% since early last year and nearly 10% in 2026 alone, the shekel is outpacing every one of its peers, even as the country remains embroiled in a multi-front conflict.

The most popular fundamental explanations for the rally are, on closer inspection, wanting.

Start with defence exports. Israel builds some of the world's cheapest and most effective weapons systems, and order books have swelled in the aftermath of the country's striking battlefield successes. Yet a boom in arms shipments has not prevented overall goods exports, adjusted for the exchange rate, from falling roughly 5% in the first quarter of 2026. Nor has it closed the country's merchandise trade deficit.

What about growth optimism? Forecasters have pushed forward expectations for a broader economic recovery from 2026 to 2027 without materially adjusting cumulative growth outcomes.

Rate differentials, another favourite culprit, are similarly stable: with the Federal Reserve expected to sit tight deep into next year and the Bank of Israel seen easing only modestly, the gap between American and Israeli government-bond yields has barely budged*.

In our view, the real answer lies elsewhere, with shifts in capital flows playing the dominant role. International investors chasing Israel's tech sector and betting on geopolitical calm are pouring money into the country, buying an estimated $6.6bn in shekels in the first quarter alone. At the same time, Israeli pension funds, insurers and other institutional investors with vast holdings in American equities—particularly technology stocks—are seeing portfolio gains that push them past their currency-exposure limits. It’s a nice problem to have, but to stay within those limits, they are selling dollars and buying shekels in the forward market.

Between non-resident investors rushing in and onshore institutional players rebalancing dollar exposures, heavy, one-directional demand in the capital markets is swamping the capacity of domestic banks and the commercial sector to absorb the inflow. The result is a rising exchange rate and a tightening correlation between the shekel and American equity indices. Israel's currency, in effect, has become a leveraged bet on the Nasdaq.

Exporters are howling, but they may find little more than a sympathetic ear at the central bank. It has become common knowledge among policymakers that in a world of widening imbalances between financial markets and real economies, small, open countries with outsized financial sectors are especially vulnerable. Economies like Australia, Canada and Switzerland have struggled to manage surges in foreign capital for decades, with monetary policy authorities—much like the Bank of Israel now—proving capable of smoothing disorderly short-term moves, but not reversing structural trends. Sustained official intervention looks unlikely.

A view on the shekel is thus, in essence, a view on the American artificial-intelligence boom. If tech stocks maintain their upward momentum over the year ahead, a surge in the dollar exchange rate to 2.6—or beyond—is not out of the question. If they reverse dramatically lower in a reprise of the post-1999 dot-com collapse, the shekel could easily break back below 3.3.

For now, Israel's capital-flow tail will continue to wag the real-economy dog. It will not be the last small, open economy to discover that in an age of footloose capital, the exchange rate belongs to everyone except the country printed on the banknote.

- Karl Schamotta, Chief Market Strategist, Karl.Schamotta@Corpay.com

*Note that under covered interest rate parity, USDILS forward points should mechanically reflect the interest rate differential between the two currencies. But in practice they deviate significantly due to structural imbalances in Israel's FX swap market, with lopsided flows overwhelming natural counterparties, pushing the cross-currency basis in a persistently-negative direction.