Middle East Tensions Flare: What "Operation Rising Lion" Means for the Israeli Shekel and Bonds

The financial world held its breath this morning as news broke of reported Israeli military action against Iranian nuclear and military targets. Dubbed "Operation Rising Lion," this significant escalation on June 13, 2025, has sent immediate ripples across global markets, triggering a classic "flight to safety." For investors with exposure to the Middle East, particularly Israel, understanding these shifts is paramount.

Let's break down the immediate impact on the USD/ILS exchange rate and Israeli government bonds, and consider the precise implications for investment portfolio.

The Immediate Aftermath: Markets React to Escalation

Geopolitical events of this magnitude rarely leave markets untouched, and today was no exception. The news of the Israeli strikes and subsequent Iranian retaliation (with drones launched towards Israel) immediately heightened global risk aversion.

One of the first and most visible indicators of this tension was the sharp rise in Brent Crude oil prices. From approximately $69.36 per barrel yesterday, prices surged to between $73.03 and $75.37 per barrel by midday today—an increase of over 5%. This jump reflects deep market anxieties over potential disruptions to global oil supply, especially from the critical Strait of Hormuz.

USD/ILS: The Shekel Under Pressure

In times of global uncertainty, the US Dollar often acts as a safe haven, attracting capital from around the world. This dynamic was clearly at play today in the foreign exchange market.

The USD/ILS exchange rate saw an immediate appreciation of the US Dollar against the Israeli New Shekel. Just yesterday, the rate stood at approximately 3.561. Following the news this morning, it quickly climbed to 3.568 - 3.598, reflecting a rapid depreciation of the Shekel by 0.2% to 1.06%. This swift movement underscores how quickly investor sentiment can shift towards perceived stability.

In the short term, expect continued upward pressure on the USD/ILS. The ongoing uncertainty and the potential for further escalation will likely keep investors favoring the dollar. If the conflict intensifies or broadens, we could see the Shekel face even greater headwinds as capital seeks safer shores. The Bank of Israel may consider interventions to stabilize the currency, but their effectiveness will depend heavily on the geopolitical trajectory.

Israeli Government Bonds: Yields on the Rise

The Israeli government bond market also felt the heat, with yields experiencing a notable surge. When investors perceive higher risk, they demand greater compensation for holding a country's debt, leading to higher yields (and consequently lower bond prices).

The yield on Israel's benchmark 10-year government bond, which was around 4.15% yesterday, jumped significantly to 4.55% - 4.65% by midday today—an increase of 40-50 basis points. This sharp rise reflects a clear increase in the risk premium investors are demanding for Israeli sovereign debt.

Beyond immediate risk, there are deeper fiscal implications. Military operations are inherently costly, and prolonged conflict could significantly increase Israel's fiscal expenditure, potentially leading to larger government deficits and increased borrowing. This elevated supply of debt, coupled with heightened risk perception, inevitably puts upward pressure on yields.

Furthermore, international credit rating agencies have already expressed caution. S&P Global Ratings, in its May 9, 2025, update, maintained a "Negative Outlook" on Israel's 'A/A-1' ratings, explicitly citing the risk that "the conflict... could substantially weaken Israel's economy, public finances, and balance-of-payments position, particularly if the conflict escalates." Fitch Ratings echoed this sentiment with a "Negative Outlook" in March 2025. This pre-existing caution means the current escalation significantly increases the probability of a credit downgrade, which would further push up borrowing costs and potentially trigger further outflows.

Navigating the Volatility: Key Investment Considerations

For institutional investors and portfolio managers, the current environment demands a highly cautious and agile approach:

• Currency Exposure Management: For portfolios with significant exposure to Israeli New Shekel-denominated assets, actively considering hedging strategies is crucial to mitigate potential further depreciation. This could involve increasing allocations to stable hard currencies such as the US Dollar, Japanese Yen, or Swiss Franc. More specifically, utilizing currency derivatives like forward contracts (e.g., selling ILS forward against USD) or options (e.g., buying USD/ILS call options to protect against Shekel depreciation) can provide direct protection against adverse currency movements without liquidating underlying assets. For those not holding ILS, a speculative long position in USD/ILS could be considered if further escalation is anticipated.
• Fixed Income Strategy: A distinctly "risk-off" stance is advisable for Israeli government bonds. This might necessitate reducing or exiting exposure, especially to longer-duration instruments, which are inherently more sensitive to interest rate and yield changes. Instead, consider reallocating capital towards highly-rated sovereign bonds from economies perceived as safe havens, such as U.S. Treasuries (T-bills, notes, and bonds) or German Bunds. Exploring short-duration, high-quality corporate bonds from globally diversified companies less exposed to regional geopolitical risk could also be an option. Close monitoring of announcements from credit rating agencies is paramount, as any confirmed downgrade would fundamentally alter the risk-reward profile of Israeli sovereign debt and likely necessitate further portfolio adjustments. For active traders, this environment may present opportunities for short positions on Israeli bond futures or long positions on inverse Israeli bond ETFs, though these carry higher risk.

The Road Ahead

The Israeli strike on Iran, "Operation Lion's Rise," marks a critical escalation in Middle Eastern geopolitics. The immediate market reactions—a stronger US Dollar against the Shekel and rising Israeli bond yields—are clear indicators of heightened risk aversion. While these initial shifts align with established economic principles, the long-term trajectory of USD/ILS and Israeli sovereign debt will depend entirely on how this conflict evolves, the nature of any further retaliation, and the effectiveness of international efforts to de-escalate the situation. In this volatile landscape, continuous monitoring of geopolitical developments and a disciplined approach to risk management will be paramount for investors.