Psagot warns: A dramatic jump in the defense budget will threaten the Israeli economy
The weekly review by Psagot Investment House highlights the divergence between global central banks and the expected surge in Israel's defense spending, which poses risks for investors.
Financial markets continue to face a period of uncertainty, as global interest rate decisions and budgetary developments in Israel may significantly impact investors. A weekly review by Psagot Investment House points to two main risk centers: one on the global stage regarding central bank policy, and the second in Israel concerning the expected increase in defense spending and its implications for the national budget.
According to the Psagot review, there is a significant gap between the conduct of the European Central Bank (ECB) and the Federal Reserve (Fed) in the United States. The ECB decided to leave interest rates unchanged in July, against the backdrop of volatility in energy prices and an assessment that, at this stage, there are no signs of significant inflationary pressure stemming from wage increases. European forecasts project inflation in 2026 to be around 3%.
Conversely, in the United States, the assessment is that the Fed is also expected to keep interest rates steady, but Psagot warns that there is a possibility of a surprise from the central bank. The rise in oil prices and the jump in 10-year US Treasury yields, which reached 4.68%, are sparking discussions among Fed members regarding the possibility of an additional rate hike.
Psagot notes that a sharp change in US interest rate policy could create market turmoil, especially at a time when investors are pricing in the continued growth of the artificial intelligence sector and its impact on technology companies.
At the same time, the review addresses the economic reality in Israel and warns of the consequences of the continued rise in defense spending. Estimates suggest that following the Iron Swords war, Israel may increase its defense budget by approximately 300 billion shekels over the next decade.
"By 2030, defense spending could reach about 11.3% of GDP and account for about 40% of the state budget," Psagot projects.
Such a move could lead to an increase in the deficit, a rise in the debt-to-GDP ratio, and upward pressure on government bond yields.
Accordingly, Psagot recommends that investors adopt a cautious approach. In the US, they suggest preparing for the possibility of a surprising change in Fed policy, and in the Israeli bond market, they recommend maintaining a shorter duration in investment portfolios due to the risk of rising yields in the medium and long term.
