Israel's resilience has a price
Strong markets and falling risk premiums mask deeper questions about growth, security and the future.
During the hours when Israel and Iran exchanged threats and missiles, the dollar fell by about 2.5% against the shekel. For most major currencies, that is the kind of move typically seen over an entire year. A quick glance at Calcalist's homepage during those hours captured the surreal reality Israel has been living through since October 7, and even more so since the first round of direct confrontation with Iran.
Three headlines appeared side by side: school closures due to the war, a $60 million funding round for an Israeli tech company, and the dollar's collapse after Iran announced a ceasefire. Three headlines, but ultimately one story about the Israeli economy in 2026.
1.
Israel entered the latest round with Iran in a far stronger economic position than many would have imagined in the aftermath of October 7.
Israel's risk premium, as reflected in five-year CDS spreads, is near historic lows at around 54 basis points, roughly the level recorded before the October attacks. To put that into perspective, in early March, just days after the first combined U.S.-Israeli strikes on Iran, CDS spreads stood at approximately 86 basis points. In other words, Israel's risk premium has fallen by more than 37% in just over three months.
The shekel, which last week became the world's strongest-performing currency against the dollar, remains exceptionally strong despite recent volatility. The dollar is once again trading near NIS 2.95, after briefly falling toward NIS 2.8 two weeks ago, a level not seen in roughly three decades. The Tel Aviv Stock Exchange, despite recent declines, remains close to record highs.
Meanwhile, the government deficit has continued to narrow, falling from 4.2% of GDP in March to approximately 3.75% in May, driven largely by surprisingly strong tax revenues. According to Israel Tax Authority data, tax collection in January-May 2026 increased by about 10% in real terms compared with the same period last year, led by a more than 13% jump in income tax receipts.
At the same time, the Bank of Israel has managed to bring inflation back to the middle of its target range, around 2%, despite the fact that most recent economic research classifies military conflicts as inherently inflationary events.
At first glance, the picture borders on the absurd. After all, Israel has spent nearly three years dealing with overlapping military campaigns, repeated reserve mobilizations, regional threats, and a dramatic surge in defense spending. These are hardly the conditions one would normally associate with a strengthening currency, falling risk premiums, or record-high stock markets.
2.
Yet the situation is unusually delicate.
Markets are no longer pricing the war the way they did at the beginning. In the early stages, investors feared a collapse in economic activity, capital flight, declining investment, a sharp depreciation of the shekel, and a spike in Israel's risk premium.
Instead, the opposite largely occurred.
Markets began pricing in what they viewed as a significant improvement in Israel's geopolitical position, and financial assets responded accordingly. At the same time, investors increasingly concluded that the Israeli economy had developed an extraordinary capacity to adapt.
Businesses learned to operate under restrictions. Workers learned to balance civilian careers with reserve duty. International companies remained engaged. The technology sector continued raising capital. Private consumption recovered more quickly than expected.
That does not mean the war came without a cost. It certainly did.
Growth has suffered. Data released in May show that real GDP per capita, adjusted for seasonality, remains roughly at 2022 levels. Following a steep decline during 2023 and 2024, the economy recovered, but has yet to move meaningfully beyond its pre-war trajectory.
Moreover, the Bank of Israel's economic activity index, which seeks to anticipate trends in real economic activity, has declined for three consecutive months. At the same time, defense spending has climbed to levels that would have seemed unimaginable just a few years ago, approaching 8% of GDP.
3.
The central question is no longer what happened, but what happens next.
The mistake would be to focus exclusively on the economic data of the past month. Markets do not price the present; they price the future.
In the first two rounds of confrontation with Iran, the future appeared relatively straightforward. The economic costs were clear, but so was the strategic logic. Investors believed each round weakened Iran, reduced regional threats, and brought Israel closer to a more stable security environment.
In other words, markets were not merely pricing war, they were pricing the possibility of victory: greater stability, reduced threats, and potentially even broader regional integration through an expansion of the Abraham Accords.
But a third round presents a different challenge.
Economic resilience is not a permanent feature. It is a resource.
If a third major confrontation is required after two significant rounds, investors will inevitably begin asking whether a fourth and fifth round will follow. The question changes. It is no longer whether Israel can strike Iran effectively, but whether there is a clear endgame.
At that point, markets may begin asking whether Israel has entered a prolonged, multi-front war of attrition involving Iran, Hezbollah, Hamas, and other regional actors, albeit in weakened form.
If that becomes the prevailing assumption, defense spending ceases to be a temporary burden and instead becomes a permanent feature of the economy. It becomes the new normal.
The question then shifts from whether Israel is approaching the end of a crisis to whether it is adapting to life within one.
That distinction matters enormously for investment decisions, asset valuations, and long-term growth prospects.
4.
Risk mapping suggests a highly sensitive and increasingly complex environment.
At the center of these concerns is Israel's technology sector, the primary engine of economic growth and the foundation of the country's export performance, tax revenues, foreign investment inflows, and currency strength.
This is where uncertainties begin to accumulate.
There is no crisis today. But there is growing uncertainty on two fronts.
The first is local: reserve duty mobilizations, disruptions to education systems, a persistently strong shekel, and a weak dollar that pressures exporters.
The second is global: the AI revolution, whose long-term impact on the technology industry, labor markets, and value creation remains deeply uncertain.
In addition, American support regarding the Iranian front appears less certain today than it did in February.
Meanwhile, Israel's international image continues to deteriorate at a troubling pace.
Any one of these factors might be manageable on its own. Together, however, they paint a more concerning picture.
The macroeconomic indicators are already beginning to flash warning signs. Private consumption rebounded quickly after previous rounds of fighting, but the recent decline in the Bank of Israel's activity index suggests momentum is weakening.
This is not a recession, nor is one currently expected. But neither is it an economy operating at peak capacity.
Optimistic forecasts calling for growth of approximately 5.6% in 2027 are far from guaranteed if military confrontations continue to recur and intensify.
The war affects precisely the areas most sensitive to long-term growth: labor participation, business activity, educational continuity, and household confidence.
Even if summer conditions mitigate some of the immediate disruption, they do not eliminate the underlying risks.
More importantly, these risks are not independent of one another.
The economy can withstand a somewhat larger deficit. It can absorb slightly weaker growth. It can even manage a weaker currency.
The challenge arises when these risks materialize simultaneously.
Adding to the uncertainty is a political system entering what is likely to become a prolonged and highly contentious election campaign.
Each individual risk may appear manageable. Their cumulative effect could prove far more significant.
5.
The reality is that Israel's economic performance has been considerably stronger than many expected two years ago, and financial markets continue to signal confidence. That much is undeniable.
For now, investors appear to be betting that the war remains a temporary disruption on the path toward a more stable regional reality.
Unlike previous rounds, however, the greatest risk is no longer the next missile strike, the next military operation, or even several additional billions of shekels in defense spending.
The real risk is that war itself ceases to be a temporary disruption and instead becomes a permanent background condition.
The difference between those two scenarios could ultimately determine whether Israel experiences another chapter in an ongoing conflict, or a fundamental shift in its long-term economic trajectory.
