Israel's shekel weakened about 2.9% against the U.S. dollar in the third quarter, as the country's big institutional investors sold far fewer dollars than in the spring, according to data the Bank of Israel published last week. Institutions' net foreign-currency sales fell to about $4.4 billion in the July-to-September period from about $13.8 billion in the second quarter, the central bank said.

The figures matter beyond Tel Aviv. Israel's pension funds and insurers hold large portfolios of U.S. and other overseas equities, and the way they hedge those holdings has become one of the main forces moving the shekel. The quarter also showed a sharp contrast with Asia: the dollar fell about 12.4% against the South Korean won and about 3.3% against the Japanese yen over the same three months, the Bank of Israel data showed, while it gained ground on the shekel.

Who sold dollars, and who bought

The shekel also weakened about 2.4% against the euro and about 2.8% against a basket of the currencies of Israel's main trading partners, the central bank said in its quarterly review of the foreign-exchange market, released on Nov. 3.

The mix of buyers and sellers shifted. The business sector, which had been a net seller of about $12.1 billion of foreign currency in the second quarter, turned into a net buyer of about $1.7 billion. Banks and other financial firms were net buyers of about $3.7 billion. Nonresidents were net sellers of about $6.5 billion, close to the roughly $6.4 billion of the previous quarter.

The Bank of Israel itself stayed out of the market. It made no net foreign-currency purchases in the third quarter, after net purchases of about $1.8 billion in the second quarter, when it had been leaning against a rapidly strengthening shekel.

Activity cooled. Average daily trading volume between the domestic banking system and its customers fell about 9.1% to $16 billion. Foreign participants took a larger role, with nonresidents' share of that volume rising about 5.2 percentage points to about 41.4%. In the wider spot and forward market, including trades booked abroad, nonresidents accounted for about 87% of activity, the central bank estimated.

Volatility eased as well. Realized volatility in the shekel-dollar rate fell 1.7 percentage points to an average of 9.0%, while implied volatility on over-the-counter options edged up 0.1 point to about 10.1% at the end of the quarter.

Why Israeli institutions move the shekel

The swing in institutional flows reflects a mechanism that local analysts have described for months. Israeli institutions aim to hold a set level of foreign-currency exposure, so when U.S. stocks rise they sell dollars to rebalance, and when Wall Street falls the pressure reverses, according to a Globes report in late June that cited Jonathan Katz, chief economist at Leader Capital Markets.

That dynamic helped push the shekel to about NIS 2.8 per dollar in May, before it weakened to around NIS 3 by late June, Globes reported at the time. The Bank of Israel bought $800 million of foreign currency in May to slow the shekel's climb, the paper said. Modi Shafrir, chief markets strategist at Bank Hapoalim, told Globes that a lasting weaker shekel could feed through to inflation over six months or more.

The third-quarter data suggest that the heavy selling of the spring did not continue. With institutions selling roughly a third as many dollars as before and the business sector switching to buying, the domestic support for the shekel thinned, even as the dollar slid against many Asian currencies. Readers following the won's side of that move can see how Seoul's own figures looked in Korea's October reserves report.

Reserves edge up to $237.8 billion

A separate release on Nov. 5 showed Israel's foreign exchange reserves stood at $237.773 billion at the end of October, up $775 million from the end of September. The reserves are equal to 34.3% of gross domestic product, the Bank of Israel said.

The central bank attributed the increase mainly to revaluation, which added about $1.755 billion. Government foreign-exchange activity, which includes Bank of Israel payments and receipts in foreign currency, subtracted about $965 million. The release did not list any foreign-currency purchases by the central bank in October.

For investors in Asia, Israel's reserve pile and its institutions' overseas holdings tie the shekel closely to the U.S. equity market, where many Asian funds also hold large positions. A sell-off on Wall Street tends to push Israeli institutions to buy shekels back, while a rally pushes them to sell.

The next marker is the Bank of Israel's monthly reserves report for November which will show whether the central bank again stayed out of the currency market.