US-Israel Tensions Threaten Credit Rating as Markets Underprice Risk
US-Israel friction threatens Israel's credit rating, but markets have yet to fully price in the risk, warns Meitav Chief Economist Alex Zezinshky.
The deterioration of relations between Israel and the USA could become a major threat to Israel's credit rating, yet financial markets are not yet fully pricing in this risk, warns Alex Zezinshky, Chief Economist at Meitav Investment House, in his weekly macro review.
According to Zezinshky, last week's events illustrated the decline in Israel's standing in Washington. On election day, the US president announced the cessation of aid to Israel, and the vice president cited ties with Israel among the reasons for an electoral defeat. These developments may carry economic consequences far beyond the scope of the aid itself.
The central reason is that American support is considered one of the pillars of Israel's credit rating. Zezinshky recalls that rating agency Moody's already warned in 2025 that a substantial erosion in Israel's relations with its key allies, including the USA, would significantly and negatively impact its credit rating. S&P has also previously emphasized the importance of relations with the USA.
The Economic Cost: Three Additional Percentage Points in Debt
According to a Bank of Israel calculation presented by Zezinshky, in a scenario where defense expenditures increase by approximately 35 billion shekels annually, Israel's debt-to-GDP ratio is projected to reach 83% at the end of a decade with continued US aid, compared to 86% without it.
This is a three-percentage-point gap that could weigh heavily on Israel's fiscal position and its ability to withstand additional economic shocks. Beyond the direct budgetary impact, a downgrade in the credit rating could drive up the government's borrowing costs.
However, according to the review, investors are still not attaching significant weight to this risk. Israel's risk premium, as measured by CDS contracts and the government's dollar bond spreads, barely reflects the worsening relations with the USA.
The Bond Market Is Already Signaling Trouble
Since the elections in Israel, the TA-125 index has fallen by about 4.6%, mirroring declines in the S&P 500 and emerging markets. The shekel weakened by 4.2% against the dollar, though Zezinshky notes that most of the depreciation aligns with the historical correlation between the shekel and the US stock market.
By contrast, Israeli government bonds exhibited unusual weakness: the yield on 10-year shekel bonds rose by about 0.1 percentage points since the elections, while yields in other major countries declined.
Against this backdrop, Zezinshky remains cautious regarding strategic investment in Israeli risk assets. He estimates that the formation of a government might support short-term gains, but prefers medium-duration government bonds, with an emphasis on CPI-linked bonds.
