Citi: Protest movement threatens Israel’s bond market

Citi Capital Markets worries that the protest movement against the high cost of living threatens Israel’s bond market as the government loosens fiscal restraints to meet the protesters’ demands, thereby weakening Israel’s fiscal position and forcing monetary tightening.“A protest movement has evolved in the past few weeks from a Facebook campaign that contested the price of cottage cheese, to a tent city in Tel Aviv protesting the cost of housing, to a broad populist movement which on Saturday night attracted 300,000 demonstrators, or 4 percent of the entire Israeli population,” analyst David Lubin said.He noted that the protest movement has no formal links to any political parties, and the issues that have brought protesters together are many and varied. At the heart of the protest is a set of complaints about the cost of housing, but plenty of other issues feature strongly, including the level of indirect taxation, the size of fiscal transfers to ultra-Orthodox communities and to settlers, the failure to improve Israel’s transport infrastructure, the deterioration in the quality of education and healthcare, the size of Israel’s defense budget, and the dominance of a small number of families in the structure of Israel’s corporate ownership, he said.Lubin believes that Israel seems an unlikely candidate for a mass protest movement, as its democracy is robust, and the performance of the economy has been almost exemplary.But in some ways it makes sense to think of this protest movement as some kind of distant cousin of the Arab revolutions, he said, as Israeli protesters are motivated, like their Arab counterparts, by a deep sense of injustice. He added that the incidence of Israeli poverty is very high by OECD standards, while direct tax cuts and a narrow structure of corporate ownership have helped to underline problems of inequality.The government’s response to the protest movement whose momentum seems undiminished right now is evolving, but is likely to lead to it is likely to involve structural reforms and fiscal loosening, according to Lubin. The structural reform agenda is likely to include measures to improve competition and reduce cartelization in a variety of sectors. Possible areas of reform include the food industry, retail, banking, cement and telecoms. In addition, measures to increase the effective supply of land by reducing the dominance of the Israel Land Administration are also likely. Structural measures could be good news for Israel’s growth potential, but will take time. In the shorter run, fiscal expansion is likely to dominate.Lubin questioned whether Israel’s policy response to the protest movement is consistent with the recent rally in Israeli fixed income. Israel’s fixed income markets have seen a strong rally in recent weeks, and the market is now barely pricing in any interest rate hikes over the next nine months. “This seems wrong to us,” said Lubin.He concluded that even if the public finance consequences of the protest movement are relatively modest, Israel’s fiscal position is more likely to weaken than strengthen as a result, and that will at least raise the question of whether monetary policy needs to be tighter. And since the recent weakening of the shekel is more likely to be inflationary than not, it seems unreasonable for the market to be pricing so little in the way of rate hikes.