Priced From the Outside

A recent Bloomberg article caught our attention. Tina Vandersteel of GMO, one of the more respected emerging-market debt investors in the institutional world, is buying Israeli USD-denominated bonds through a technical relative-value trade.

For much of the past few years, Israeli assets have been viewed primarily through the lens of geopolitical risk. War, political uncertainty, ratings pressure, regional escalation, and headline volatility have all contributed to a visible risk premium in parts of Israel's capital markets.

That is understandable. Israel is not a risk-free market. No market is.

But in fixed income, risk and mispricing are not the same thing. And when a sophisticated global credit investor starts treating Israel as a market to be analyzed rather than a headline to be avoided, that shift deserves attention.

What the Trade Tells Us

The mechanics are worth understanding briefly, because they illustrate something broader.

In bond markets, investors measure value through spreads — the extra yield a bond offers above a safer benchmark like U.S. Treasuries. If an Israeli dollar bond yields meaningfully more than the relevant U.S. benchmark, that spread is the market's compensation for credit risk, liquidity risk, geopolitical risk, and other uncertainties.

Credit default swaps offer another way to price the same risk. Buying CDS protection on Israel means paying an annual premium to insure against a credit event. When the bond's spread is wider than the cost of that protection, the bond is screening cheap relative to its own insurance — a negative CDS basis. Israeli dollar bonds have recently traded roughly 50 basis points cheaper than the cost of insuring them.

The structure of the trade is what makes it interesting. By owning the bond and buying CDS protection, the investor is not simply making an unhedged bet on Israel. The CDS acts, in effect, like insurance against a severe credit event, while the bond still offers extra yield if that event does not occur. It is not a naked bet on a country at war. But it is also not a view-free arbitrage. The protection is there to manage the risk of the position, not to eliminate the view behind it.

And the position expresses a judgment: that the war premium embedded in Israeli dollar bonds is larger than the underlying credit warrants. Vandersteel has been explicit about the framing, comparing the setup to Russia before 2022 — strong fundamentals overshadowed by geopolitical fear, where an investor could own the bonds and own protection in a single package. In her view, Israel is the one market in its region still carrying a significant war premium. Buying that package is a way to be long that view while hedging the tail she cannot predict.

That distinction matters. This is not a passive trade waiting for mean reversion. It is a considered judgment, from a three-decade emerging-market credit veteran, that the market is over-discounting Israeli risk — and a willingness to put capital behind it. Sophisticated global investors are beginning to analyze Israeli credit not just as a headline to avoid, but as a market where risk can be priced, compared, hedged, and, in her assessment, mispriced.

The Global Market and the Local Market Are Not the Same

But hard-currency (i.e., USD-denominated) bonds are only one part of the Israeli debt market — and arguably the part most exposed to global perception rather than local reality.

Israeli dollar bonds and CDS are primarily part of the global institutional market. They are traded and analyzed by emerging-market debt funds, sovereign credit investors, hedge funds, and global relative-value managers. In that market, Israel is compared to other sovereign credits, regional risks, and rating categories. Foreign investors may price Israel through the framework of sovereign risk and geopolitical escalation. They see the headlines first and the market structure second.

The domestic market appears to be telling a different story.

There is no CDS market for local ILS-denominated bonds. Risk has to be read through other signals: government yields, corporate spreads, liquidity, new-issue concessions, fund flows, sector dispersion, and the behavior of the shekel itself. And today, those signals do not suggest a market demanding a major war premium. Israeli government yields have remained resilient, local institutions remain active, and the shekel has strengthened materially against the dollar. Based on conversations with traders inside the market, the domestic market is not pricing Israel as a distressed wartime credit.

That does not mean the risk is imaginary. It means the investors closest to the market are not pricing the risk the same way as foreign investors in dollar bonds and CDS.

That gap is the more interesting story. The question is not simply whether Israel carries a war premium. The better question is: where does that premium appear, who is pricing it, and does the local market tell a different story than the global one?

The Shekel Adds a Third Signal

If Israel were being broadly abandoned, one would expect persistent pressure on the currency. But recent periods of shekel strength suggest a more complicated picture. Year to date, as of the end of May 2026, the shekel has appreciated nearly 12% against the dollar. Demand to convert dollars and euros into shekels can signal local confidence, capital inflows, hedging activity, or investor willingness to own Israeli exposure despite the headlines.

That does not eliminate risk. But it challenges the simplest version of the story.

The headline narrative may say Israel is too risky. The currency market may say demand for shekels remains strong. The dollar bond market may price a geopolitical premium. The domestic bond market may price risk differently.

The point is not to choose one signal and ignore the others. The point is to understand how they interact.

The Premium Has Already Moved

It is also important not to overstate the case.

The largest broad-based repricing of Israeli risk occurred in the immediate aftermath of October 2023, when uncertainty was highest and investors demanded materially more compensation to own Israeli exposure. Since then, parts of that risk premium have compressed sharply — Israel's CDS index has fallen more than 60% from the post October 7 highs it reached in October 2024. Yet the basis trade has remained attractive even as outright spreads tightened: through 2026, the CDS basis on Israel's longer-dated dollar bonds has held firmly in negative territory, with the bonds consistently screening cheap relative to credit protection rather than snapping closed.

That persistence is itself the signal. The dislocation did not vanish when the headline risk eased, and it did not close after the regional escalation earlier in 2026. A durable mispricing is a different thing from a one-off panic.

The opportunity today is not a simple "buy Israel because it is cheap" trade. Markets are more nuanced than that. Risk premiums can appear, compress, migrate, and disappear. What looks cheap in one part of the market may look fair in another. What is obvious in dollar bonds may not exist in shekel bonds. What is priced by global investors may not be priced the same way by domestic investors.

The opportunity has become more selective. That is why local analysis matters.

From Headline Risk to Market Analysis

The most important shift is conceptual.

For many global investors, Israel is still filed under "geopolitical risk." That label may be accurate, but it is incomplete. A market can carry geopolitical risk and still be attractive. A bond can have real uncertainty and still be mispriced. A country can face war-related headlines and still offer compelling risk-adjusted opportunities.

The question is never simply, "Is there risk?" The question is, "Am I being paid enough for the risk I am taking?"

In some parts of Israeli credit, the answer may be yes. In other parts, no. A seasoned global investor looked at the dollar market and concluded the answer was yes.

The Kotel View

At Kotel, our focus is not on making broad political calls or predicting the next headline. Our interest in the Israeli fixed-income market is analytical: it is underallocated, underresearched, and structurally distinct in ways that we think reward close attention.

The Vandersteel trade is notable less for the position itself than for the view underneath it: that Israel’s wartime risk premium in the dollar bond market is too high and may compress. That view is clearest in the hard-currency market, where Israeli dollar bonds and CDS provide a visible way to measure how foreign investors are pricing Israel from the outside.

The domestic market tells a different story. There is no comparable war premium at home: government yields have stayed resilient, local institutions remain net buyers, and the shekel has strengthened rather than weakened. The investors closest to the risk are not pricing it the same as foreign investors. The premium, in other words, is not really a fact about Israel's credit. It is a fact about distance.

That distance is structural. Foreign investors own less than 8% of ILS-denominated Israeli government bonds and under 1% of the ILS corporate market. Much of that corporate universe sits outside the major global indices, with little to no international research coverage — even though it trades transparently, and daily, on the Tel Aviv Stock Exchange. The inefficiency is not only in individual bond pricing. It is also in access, research coverage, market segmentation, and the gap between local understanding and global allocation.

Israel's bond market deserves a more serious place in the global allocation conversation — not because all Israeli bonds are cheap, and not because the risks are imaginary, but because how the world prices Israeli risk and how Israel prices itself so often diverge. More often than not, and particularly when it comes to Israel, the view from the outside and the view from within are not the same. For anyone trying to understand the market, that gap is the most interesting place to look.

About Kotel Investment Management: We serve as a bridge between U.S. capital and Israel’s overlooked fixed income markets, sharing insights and perspective through our research and thought leadership.

This content is for informational and educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any securities.