Is the Shekel Too Strong? The Hidden Link Between Wall Street and USD/ILS

The shekel is once again at the center of attention. The Bank of Israel's representative dollar exchange rate stood at just 2.954 shekels on Friday, August 14, after a daily decline of almost 1%. But the more interesting story is not simply the dollar's decline. The important question is why the shekel remains so strong, and whether Israel has developed a mechanism that turns every significant Wall Street rally into another wave of demand for shekels.

In other words, the issue may no longer be only a weak dollar or a strong Israeli economy. Israel's institutional investors may simply have become too large relative to the local foreign-exchange market.

It is not just the dollar getting weaker

The easiest explanation for the shekel's appreciation is weakness in the dollar globally. The dollar has indeed weakened recently as U.S. economic data softened and expectations for a more hawkish Federal Reserve were reduced. But the strength of the shekel cannot be explained solely by the U.S. story, and the best evidence comes from comparing the shekel with other currencies.

During the second quarter of 2026, the shekel appreciated by approximately 5.9% against the dollar, but it strengthened even more, about 6.6%, against the euro. On the nominal effective exchange-rate index, which measures the shekel against the currencies of Israel's main trading partners, it appreciated by around 6.1%.

In other words, this is not simply a weak-dollar story. It is also a strong-shekel story.

Why is the shekel so strong?

There are several reasons. The first is the decline in Israel's risk premium. During periods when markets believe Israel's security and political risks are declining, investors require less compensation for holding Israeli assets. Capital returns to Israel, foreign investment increases and the shekel receives support.

But alongside this is another factor that has become increasingly important in recent years: institutional investors.

Pension funds, insurance companies and provident funds now hold a substantial share of Israeli household savings in overseas markets. From a diversification perspective, that makes perfect sense. The issue begins when these institutions hedge part of their foreign-currency exposure, and this is where the direct connection between Wall Street and the shekel emerges.

When the S&P 500 rises, institutions need to sell more dollars

Suppose an Israeli pension fund owns $10 billion of U.S. assets and wants to maintain a 50% currency hedge. That means it hedges $5 billion of exposure. If the S&P 500 rises 10%, the portfolio is suddenly worth $11 billion. To maintain the same hedge ratio, the fund must increase its hedge from $5 billion to $5.5 billion.

In effect, the rise on Wall Street creates a need to sell an additional $500 million against the shekel.

When similar transactions are carried out at the same time by pension funds, provident funds and insurance companies managing hundreds of billions of shekels, the resulting foreign-exchange flow can become extremely large. This is not merely a theoretical explanation. The Bank of Israel has previously described how rising global equity prices increased the value of institutions' foreign assets and led them to increase currency hedges through foreign-currency sales.

The 2026 numbers are becoming difficult to ignore

During the first quarter of 2026, Israeli institutional investors made net foreign-exchange sales of approximately $5.8 billion. In the second quarter, that figure jumped to about $18.3 billion. That is an enormous amount relative to the size of the Israeli market.

This raises the key question: is the shekel still trading in a market where the price is primarily determined by importers, exporters, foreign investors, interest rates and the condition of the economy, or has one domestic sector, institutional investors, become large enough for its activity to move the currency structurally?

An important distinction is needed. Institutions do not necessarily sell physical dollars every time equities rise. Much of their hedging takes place through forwards, swaps and other currency derivatives. But the counterparty, usually a bank or another financial institution, must manage the exposure created by the transaction. Derivative trades can therefore ultimately generate buying and selling pressure in the underlying currency market as well.

A hedging machine now connects Tel Aviv to Wall Street

The dynamic is relatively simple. Wall Street rises, the value of institutions' foreign equity portfolios rises, their dollar exposure increases, they increase their hedges, dollars are sold against shekels and the shekel strengthens.

This means the success of the U.S. equity market can almost automatically create appreciation pressure on the Israeli currency.

When the trend reverses, the same mechanism can work in the opposite direction. Sharp declines on Wall Street reduce institutions' dollar exposure, lead to hedge reductions and can create renewed demand for dollars. This is one reason USD/ILS has become so sensitive to movements in the U.S. equity market.

Have Israeli institutions simply become too big for the FX market?

That is now a question worth discussing at the policy level. There is nothing wrong with a pension fund hedging currency risk. Quite the opposite. It manages savers' money and attempts to control portfolio risk. The problem is systemic.

What makes sense for each institution individually does not necessarily produce the right outcome when everyone does the same thing at the same time. As Israel's pension system grows, monthly contributions continue to flow and exposure to international markets increases, hedging activity expands as well. But the Israeli foreign-exchange market does not necessarily grow at the same pace.

The result is a situation in which a perfectly legitimate risk-management decision by institutional investors can turn into a macroeconomic force influencing the exchange rate of an entire country.

An excessively strong shekel has a price

A strong shekel is not necessarily bad. It makes imports, foreign travel and dollar-priced goods cheaper. It also reduces inflation and gives the Bank of Israel greater flexibility over monetary policy.

But when appreciation happens too quickly, the other side of the economy begins to suffer. An exporter earning dollars while paying a large share of expenses in shekels receives fewer shekels for every dollar of revenue. Israeli technology companies that generate dollar revenues while paying salaries in Israel experience the same pressure.

What is good for Israeli consumers in the short term can therefore become a significant problem for exporters, technology companies and industry.

Could institutions be taken out of the FX market?

This leads to an idea that is at least worth discussing. If a meaningful part of the appreciation pressure does not come from real economic activity but from the technical need of institutional investors to repeatedly rebalance hedge ratios, perhaps these enormous flows should not all pass through the open foreign-exchange market.

One possible model would be for the Bank of Israel to provide institutional investors with a dedicated facility for some of their largest hedging transactions. Instead of a pension fund selling $1 billion into the market and creating immediate appreciation pressure on the shekel, it could execute the transaction against the Bank of Israel or through a centralized auction in which the central bank acts as counterparty.

The attraction of such an idea is obvious: it could reduce the impact of large technical flows on the currency's price. But the idea is considerably more complicated than it first appears.

Because in practice the Bank of Israel would be buying the dollars

If an institution wants to sell dollars and buy shekels, and the transaction is removed from the market, someone still has to take the other side. If that party is the Bank of Israel, the economic reality is that the central bank is buying those dollars and supplying shekels.

That is foreign-exchange intervention.

The Bank of Israel has done this before, but turning the central bank into a permanent counterparty for institutional hedging would be a much broader step. It could expand the central bank's balance sheet, increase foreign-exchange reserves and require it to manage the additional shekel liquidity created by those purchases.

There is also a risk of distorting the price

If the Bank of Israel buys dollars from institutional investors at a better rate than they could obtain in the market, it would effectively subsidize hedging. If transactions are carried out exactly at the market price, the question remains why the central bank should assume currency risk that would otherwise remain in the private market.

Moreover, once market participants know that the Bank of Israel stands behind large transactions, the existence of the facility itself could begin to influence market behavior.

For that reason, the solution may not be to remove institutions from the FX market completely, but rather to reduce their impact on it.

Perhaps the solution needs to be more sophisticated

Policymakers could examine fixed-time auctions for very large hedging transactions, encourage institutions to spread transactions over longer periods rather than concentrating them around sharp market moves, allow more gradual hedge adjustments, or create a mechanism under which the Bank of Israel participates only when flows cross a certain threshold and threaten to disconnect the exchange rate from underlying economic fundamentals.

There is also room to ask whether hedge ratios themselves should be less mechanical. If every 5% rise in the S&P 500 automatically requires immediate adjustment of billions of dollars in currency exposure, the mechanism can amplify market movements rather than reduce them.

The objective should not be to prevent institutions from managing risk. It should be to ensure that the risk management of the pension system does not itself become a macroeconomic risk.

What comes next for USD/ILS?

In the short term, three major forces are likely to continue determining the direction. The first is Wall Street. As long as U.S. equities continue rising, institutional hedging dynamics are likely to maintain a tendency toward foreign-currency sales.

The second is Israel's risk premium. Further improvement in the geopolitical and security environment could attract additional capital into Israel and support the shekel, while renewed deterioration could reverse the direction very quickly.

The third is the global dollar. If U.S. economic data weaken and markets increasingly price a more accommodative Federal Reserve, the dollar could weaken internationally as well. In that scenario, the shekel would receive support from both directions.

A dollar below three shekels therefore does not necessarily have to be a temporary anomaly. As long as these three forces operate together — strong U.S. equities, a declining Israeli risk premium and large institutional hedging flows — structural appreciation pressure on the shekel can continue.

But this is also a mechanism capable of reversing rapidly. A sharp Wall Street decline combined with an increase in Israeli risk could produce exactly the opposite effect: hedge reductions, renewed demand for dollars and rapid shekel depreciation.

The bottom line

The USD/ILS story is no longer simply about interest rates, inflation or war. Over the years Israel has built a very large institutional savings system that owns enormous amounts of assets overseas. That is a financial success, but it has created a side effect that did not exist on the same scale in the past: changes on Wall Street can now generate billions of dollars of hedging transactions in a relatively small currency market such as the shekel.

When institutional investors sell tens of billions of dollars over relatively short periods, it becomes difficult to view them as just another participant in the market. We may have reached the point where a new question needs to be asked: not whether Israel should stop the shekel from appreciating, but whether the structure of the Israeli foreign-exchange market is still appropriate for a world in which pension funds and insurance companies have become enormous global investors.

And if a significant part of the appreciation is being generated by almost mechanical hedging activity following Wall Street rallies, it may be time to think about how to weaken at least part of that link, without undermining a free market and without turning the Bank of Israel into the permanent buyer of every dollar institutional investors want to sell.