The forces pushing the shekel higher are bigger than the dollar
Israel’s currency has strengthened against a broad basket of currencies, highlighting the growing impact of exports, foreign investment, tax revenues and institutional investors.
Since the beginning of August, the shekel has strengthened by about 3% against the dollar, once again trading below NIS 3 per dollar. The move has returned the exchange rate to the center of Israel’s economic debate, after it dominated the agenda last year, when the shekel strengthened by more than 20% and became the world’s strongest currency.
The current appreciation is nowhere near that scale. But in an economy so heavily influenced by exports, the exchange rate remains an important indicator, particularly after national accounts data published this week highlighted the growing role of Israeli companies’ overseas activity in the country’s economic performance.
Part of the explanation can be found in the dollar itself. The DXY index, which measures the U.S. currency against a basket of major trading partners, has fallen about 1% over the past month. But it remains 1.4% higher than at the beginning of the year and 1.9% higher than a year ago.
In other words, the recent move is not simply a story of dollar weakness. The shekel is strengthening against a broader basket of currencies as well.
The nominal effective exchange rate index, the modern equivalent of what was once commonly called the “basket of currencies”, stood at 63.3 at the beginning of August and has since fallen to about 61. That represents an appreciation of roughly 3.6% in three weeks. While the shekel is not breaking new ground by this measure, the index was also around 61 at the end of June, the move reinforces the broader point: the recent rally is primarily a shekel story.
The picture becomes more interesting when viewed alongside the national accounts released this week. Israel’s economy grew at an annualized rate of 15.4% in the second quarter, following Operation Roaring Lion. The consensus had been for growth of slightly more than 8%.
The direction of the rebound was expected. Its strength was not.
But a closer look at the data shows that the headline growth figure masks an important structural change in the Israeli economy. When net exports are stripped out, the underlying expansion is considerably weaker.
A report published this week by J.P. Morgan argues that this is not a new phenomenon. Production carried out by Israeli companies outside Israel’s borders, but recorded as Israeli exports even though the goods themselves do not cross Israel’s borders, accounted for roughly half of real GDP growth over the past three years.
According to the report, the economy expanded by 8.4% in real terms from the second quarter of 2023 through the second quarter of 2026. Excluding this component, growth was only about 4%.
J.P. Morgan uses Nvidia-Mellanox as a prominent example of the phenomenon.
The distinction matters because the activity still benefits Israel. It contributes to tax revenues even though its effect on domestic demand is more limited. At the same time, some of the profits are ultimately transferred to foreign owners. As a result, gross national product, which measures income attributable to Israelis, has begun to lag behind GDP, which measures economic activity taking place within Israel's borders regardless of who owns the companies.
That raises a question that the J.P. Morgan analysis does not directly address: what does this increasingly globalized Israeli production model mean for the shekel?
There are several opposing forces at work.
The first is the current account. Revenue generated by these overseas operations is recorded as an export and therefore contributes to Israel’s current-account surplus, one of the fundamental forces supporting the shekel.
The second works in the opposite direction. Profits distributed to foreign owners eventually leave Israel through the primary-income component of the current account. Much of the money entering and leaving these companies, however, does not necessarily need to be converted into shekels.
A third channel is investment. Recent balance-of-payments data show continued foreign investment into Israel, including through foreign direct investment. That capital inflow creates additional demand for the shekel.
“The pressures for the shekel's appreciation continue to stem from the fundamental forces that characterize the Israeli economy and support this trend over time,” Kobby Levi, head of the market strategy desk at Bank Leumi's trading room, told Calcalist.
“Within the framework of these forces, we can note the surplus in the current account thanks to the activity of the high-tech sector, which was recently joined by the defense industry; the activity in the capital account, which is breaking records in 2026 thanks to huge transactions such as the sale of Waze; and continued capital raising from the venture capital industry.”
The third channel is perhaps the most interesting because it is less reversible than the others: taxes.
Companies and individuals ultimately pay their Israeli taxes in shekels. That means that when tax revenues rise sharply, some of the foreign currency generated by the economy must eventually be converted into the local currency.
The effect can be seen in the government's accounts. Tax revenues have repeatedly exceeded expectations, prompting the Finance Ministry's chief economist to revise the forecast upward three times over the past year. According to the latest data, roughly 75% of the recent increase in tax revenues came from income taxes rather than consumption taxes.
Higher tax revenues strengthen the government's finances and reduce the deficit, even as public spending continues to rise.
Another indicator of improving investor confidence is the cost of insuring against an Israeli government default. Israel's five-year CDS spread fell this week to around 54 basis points, roughly the level seen before October 7, after reaching about 145 basis points two years ago.
The combination of stronger tax revenues and a lower perceived sovereign risk premium provides another source of support for the shekel.
There is another, more mechanical force at work: Israeli institutional investors.
“According to reports from the Bank of Israel, they sold $40.5 billion in the 12 months between the beginning of the third quarter of 2025 and the end of the second quarter of 2026,” Levi said.
The pace accelerated toward the end of that period. Institutional investors sold $13.8 billion in the second quarter of 2026 alone.
What is notable is that their overall trading activity barely increased. Trading volume rose by only 1.9% during the quarter. In other words, institutional investors were not simply trading more. They were trading disproportionately in one direction.
As Israeli pension and investment portfolios grow overseas, institutions are required to manage their currency exposure. That can force them to sell foreign currency and buy shekels regardless of where the exchange rate is trading.
The Bank of Israel has attempted to moderate some of these pressures. According to Levi, it purchased approximately $1.8 billion in foreign currency in late May and early June, while interest-rate cuts were also intended to reduce some of the pressure on the shekel.
Those measures may slow the appreciation, but they have not fundamentally altered the forces pushing in the other direction.
“In the face of these forces, the Bank of Israel's actions temporarily moderated some of the pressures for the shekel's appreciation, but did not change the trend,” Levi said.
The shekel has weakened slightly against the dollar and the currency basket over the past two days, which Levi attributed partly to the relationship between the shekel and global equity markets as stocks fell amid fears of an escalation in the Persian Gulf. But he cautioned that past episodes suggest such moves tend to be temporary.
That leaves Israel with a currency story that is increasingly difficult to explain simply through movements in the dollar.
The more important story is the country's foreign-exchange machine: high-tech and defense exports, overseas production by Israeli companies, foreign investment, record transactions and the steady conversion of foreign currency by institutional investors.
As long as those flows continue, the shekel has a powerful structural source of support. Even periods of geopolitical turmoil may interrupt the trend, but they may not be enough to reverse it.
