Netanyahu's Bloc Lags as Markets Price in a Hung Knesset

Israeli financial markets took a hit on Wednesday as partial election results revealed a fragmented parliament with no clear winner for the country's leadership. Investors reacted to the stalemate by selling off assets, a move that reflected uncertainty over who will form the next government. The outcome leaves the nation without a decisive mandate, a scenario that often leads to prolonged coalition negotiations.

The tension in the markets was immediate and measurable. The Israeli shekel lost 1% of its value against the U.S. dollar. The Tel Aviv 35 stock index, which tracks the largest companies on the local exchange, closed trading 2.7% lower. Government bonds also faced pressure, with yields rising across the maturity curve. The yield on the two-year bond increased by six basis points, while the benchmark 10-year bond saw yields climb by four basis points. The 30-year bond yield gained two basis points. As yields rise, bond prices fall, indicating that investors are demanding higher returns for holding Israeli debt.

The political race is closer than expected. With more than 66% of ballots counted, Prime Minister Benjamin Netanyahu’s bloc is projected to win 56 seats in the 120-seat Knesset. His main challenger, former military chief of staff Gadi Eisenkot, is projected to take 48 seats. Arab-led parties, which sit outside the two main camps, are expected to hold 16 seats. Neither bloc has the 61 seats required to form a government alone, meaning both will need to seek partners from the minority parties.

Eisenkot declared victory earlier in the day, arguing that the preliminary numbers show a lack of confidence in Netanyahu’s administration. "The initial exit poll results indicate a complete lack of confidence in Netanyahu and his October 7 government," Eisenkot said in a statement on X. He claimed the lead gives him the first right to attempt to form a coalition. The official results are not expected until Nov. 4, but the Central Elections Committee reported a turnout of 77.7%, the highest for a Knesset election in 27 years.

The vote serves as a referendum on Netanyahu’s dominance since 2009 and his handling of the wars following the Hamas attack of Oct. 7, 2023. Supporters credit him with standing firm against international pressure, while critics cite his corruption trial and the handling of the Gaza campaign. Netanyahu also faces an International Criminal Court arrest warrant, which he has rejected. His far-right partners had warned of strong Arab participation on Tuesday, a comment that drew accusations of racism from opponents.

The 16 seats held by Arab-led parties are the key to breaking the deadlock. Ra'am leader Mansour Abbas stated that his party's vote would change the government. Joint List chairman Ahmad Tibi has outlined a plan to prevent Netanyahu from remaining in power. Amin Saikal, an adjunct senior fellow at Singapore's S. Rajaratnam School of International Studies, noted that neither Netanyahu nor Eisenkot has yet embraced the Arab parties. "Even if Eisenkot's alliance wins more seats, it's less likely to be able to form a governing majority without including Arab and left-wing parties," said Michael Feller, chief strategist at Geopolitical Strategy.

Avigdor Liberman, leader of the pro-Eisenkot Yisrael Beytenu party, has refused to rely on Arab parties for his coalition. His party is projected to win between seven and nine seats. This stance complicates the mathematics for Eisenkot, who may need every seat to reach the 61-seat threshold. The president of Israel will ask the candidate best placed to assemble a majority to form a government. If that process fails, another election may be called.

Netanyahu has served as the country's longest-serving prime minister, often staying in power through electoral stalemates. Israel held five elections between 2019 and 2022 before a government was finally formed. P.R. Kumaraswamy, an emeritus professor of Middle Eastern Studies at Jawaharlal Nehru University, expects a prolonged negotiation process once the final results are announced on Nov. 4. "It is too early to write him off," Kumaraswamy said.

The next step is the official publication of results on Nov. 4. The president will then designate a Knesset member to attempt to build a coalition. The market will continue to monitor the strength of the shekel and bond yields as the parties begin their talks. The 16 seats held by the Arab-led parties remain the deciding factor in who will lead the country.