U.S./Israel-Iran War: the Middle East On Edge
NextFin News - Israel is heading into difficult coalition negotiations after the final election count confirmed that Prime Minister Benjamin Netanyahu's right-wing and religious bloc won 53 of the Knesset's 120 seats, eight short of the 61 needed to govern. The opposition bloc led by former military chief Gadi Eisenkot took 48 seats, while Arab-led parties surged to a record 19 — a balance of power that neither side has said it wants to use.
The result leaves the country's longest-serving prime minister clinging to the largest single party but without a clear path back to power, and it hands the opposition a numerical route to a majority that its own members have repeatedly ruled out. The political stalemate arrives on top of a war economy already running a wide fiscal deficit and a sovereign risk premium near an 11-year peak — meaning the market consequences of a prolonged negotiation are being priced into assets that have little room left to absorb more uncertainty.
The Arithmetic That Neither Side Can Easily Solve
With all ballot boxes counted as of October 29, the seat breakdown leaves both camps short. The final count gives Likud 27 seats, Yashar 21, B'Yachad 12, the Joint List 11, The Democrats 8, Ra'am 8, Yisrael Beytenu 7, United Torah Judaism 7, Otzma Yehudit 7, Shas 6 and Religious Zionism 6. Grouped by bloc, that is 53 for the pro-Netanyahu parties, 48 for the opposition, and 19 for the Arab-led factions.
The math is unforgiving. Even if every member of Eisenkot's bloc agreed to work together, 48 is not 61. Adding all 19 Arab-led seats would produce a comfortable 67-seat majority, but all but one of the Jewish parties in that bloc ruled out such cooperation during the campaign. Netanyahu, for his part, has effectively ruled out relying on the Arab parties as well, and his natural partners leave him stranded at 53. The pro-Netanyahu bloc held 68 seats in the outgoing Knesset, a drop of 15.
"Whoever manages to forge new partnerships will move forward. Whoever doesn't will remain stuck," said a source familiar with the negotiations.
Israel's electoral system magnifies the problem. The Knesset is elected through nationwide proportional representation with a 3.25% threshold, and voters choose parties rather than a prime minister. Two parties that campaigned on narrow platforms fell below that line — the Reservists-Economic party with 2.63% of the vote and the People of Israel party with 1.7% — wasting votes that might otherwise have altered the arithmetic. A government needs the support of at least 61 lawmakers, and the president, after consulting party representatives, assigns the task of forming a coalition to the lawmaker deemed most likely to succeed. The largest party's leader is not automatically chosen.
The election results are scheduled to be formally submitted to President Isaac Herzog on November 4, with the new Knesset expected to be sworn in on November 10. That window is where the uncertainty concentrates: Israel has been here before. In 2021, Netanyahu's Likud won the most seats but could not assemble a majority, and an anti-Netanyahu coalition cobbled together a single-seat majority after months of wrangling. The precedent is not reassuring for anyone pricing stability.
Voter turnout reached 77.9% of eligible voters, the highest figure in decades, with 5,716,665 votes cast — a signal that the electorate saw the vote as a referendum on the war and on Netanyahu's leadership rather than a routine rotation.
The Market Was Already Pricing a War Economy. Now It Has to Price a Political One.
The election did not create Israel's financial vulnerability; it inherited it. Before a single ballot was counted, the country's sovereign risk indicators were already stretched by three years of war and a widening fiscal gap. The yield to redemption on 10-year shekel-denominated government bonds stood at 5.2%, a 13-year high and up more than half a percentage point within two weeks. The 30-year yield stood at 5.7%, compared with 4.1% a year earlier. The 10-year credit-default swap — the cost of insuring Israeli government debt against default — reached 176 basis points, an 11-year peak and above the roughly 160 basis points recorded when the war began in October 2023.
Against that backdrop, the currency market had positioned for a clean outcome. JPMorgan estimated ahead of the vote that the election could move the shekel by as much as 3% in either direction, assigning a 55% probability to an opposition victory that would see the currency strengthen 2% to 3% as concerns over judicial and institutional reforms eased. A Netanyahu win, the bank said, could trigger a 3% drop, while a broad coalition and prolonged uncertainty would leave the currency broadly steady. The bank noted that implied volatility in the FX market was pricing only about a 1% move around the election — a gap between what investors said they feared and what they paid to hedge. The bank also pointed out that the shekel had already weakened nearly 10% against the dollar between early 2023, when contested judicial reforms were proposed, and the October 7, 2023 attack.
The stalemate lands squarely in that third scenario: prolonged uncertainty. And it matters more now than it would have two years ago because the fiscal buffer is thinner. The central bank raised its forecast for the 2026 government deficit to 5.3% of gross domestic product, with the debt-to-GDP ratio climbing to 70.5%. In March, the cabinet approved a revised budget adding 32 billion shekels — about $10.4 billion, or 1.5% of GDP — for defense, plus 7 billion shekels in reserves for possible military needs. Whoever forms the next government inherits a budget that is already committed to war spending before any new policy priorities are added.
The Fiscal Fault Line Inside the Coalition Math
The coalition arithmetic is also a fiscal argument in disguise. The ultra-Orthodox parties — Shas and United Torah Judaism — were projected to win 14 seats combined, down from 18 in 2022. Their reduced representation matters because their core demand in any coalition is the continuation of broad exemptions from military service for ultra-Orthodox yeshiva students, a policy that is simultaneously a manpower problem for the Israel Defense Forces and a fiscal one for the treasury. Every exempt student is a worker outside the taxable labor force, and the war has turned military manpower into a binding constraint.
That is why the stalemate has a structural fiscal dimension that outlasts the negotiations. A government dependent on ultra-Orthodox support to reach 61 would face pressure to preserve those exemptions even as the defense budget swells; a government that breaks with them to draft more soldiers would gain labor-force capacity but lose its parliamentary footing. Either way, the deficit math does not improve during the caretaker period, and the market's 5.3%-of-GDP deficit forecast already assumes a functioning government making hard choices. The longer those choices are deferred, the less credible the forecast becomes — and the wider the risk premium has to widen to compensate.
Cyclical Uncertainty, Structural Re-Rating
The right way to read this event is to separate two forces that are being conflated. The coalition deadlock itself is cyclical: it is a negotiating problem with a terminal date. Israeli coalitions eventually form, even from worse arithmetic, and the uncertainty premium attached to "who will govern" mean-reverts once a government is sworn in. The 2021 precedent is the template — months of noise, then a working majority.
The structural shift is different, and it is not about the election at all. The risk premium embedded in Israeli bonds and the shekel has been re-rated upward by the war economy itself: a 5.3% deficit, debt at 70.5% of GDP, and defense spending that crowds out everything else. That re-rating does not reverse when a coalition agreement is signed. A government of national unity would not erase the fiscal math; it would inherit it. This is the trap for investors treating the election outcome as the source of the risk rather than as a new layer on top of it.
The transmission channel runs through the budget, not the headlines. A prolonged negotiation delays the passage of a state budget, and a delayed budget in a war economy means higher short-term borrowing, more reliance on domestic investors, and continued pressure on the shekel. With 10-year yields already at a 13-year high and the CDS at an 11-year peak, any extension of political uncertainty adds duration risk on top of war risk — and the market has already shown it demands more yield to hold Israeli debt through both.
There is a second transmission channel that the market is only beginning to price: the Bank of Israel's policy constraint. A weaker shekel imports inflation and complicates the rate path, while a widening deficit pushes yields higher and pulls the currency down. If the central bank is forced to defend the currency while the finance ministry is issuing more debt to fund the war, the two arms of the state work against each other — and the stalemate extends exactly the period in which that conflict remains unresolved. A government with a budget can set a fiscal anchor; a caretaker government can only spend.
The Counter-Thesis: Netanyahu Emerges Stronger
The strongest case against reading this as a net negative for Netanyahu is that he defied the polls and the markets. His Likud party emerged as the largest single party, and he can argue — as he has — that the public did not vote him out. A stalemate that drags into a fifth election could even favor him: he controls the levers of state during the caretaker period, and an opposition that cannot form a government looks incompetent rather than principled. Some analysts argue the opposition's refusal to work with Arab parties, combined with internal divisions, makes a replacement government less likely than another vote.
That argument is politically coherent but financially incomplete. Markets do not price who looks stronger in a campaign; they price the duration of uncertainty and the fiscal path of the eventual government. Even if Netanyahu survives as caretaker, the risk premium does not compress until there is a governing majority with a budget. The counter-thesis also underestimates the cost of another election cycle: each additional month without a budget adds to the deficit, and the deficit is already the thing driving the re-rating.
The signal that would prove the bearish read wrong is specific: a unity or rotation government sworn in by mid-December with a credible multi-year fiscal consolidation plan. That combination would compress the CDS spread and allow the shekel to recover the 2% to 3% that had been priced under an opposition-victory scenario. The signal that would prove it right is the failure to form any government by the constitutional deadline, triggering a new election — in which case the 10-year CDS moving above 200 basis points and the shekel breaking out of its post-election range would confirm that political duration is being added to war duration.
What Comes Next, and Who It Hits
In the short term, the direction is set by negotiation headlines rather than fundamentals. Every reported breakthrough or breakdown will move the shekel inside the range the market has already accepted, and bond yields will stay elevated until a budget path is visible. The exposed are holders of longer-duration shekel debt and foreign investors with unhedged Israeli equity exposure; the beneficiaries, paradoxically, are exporters in the technology sector, which earns in dollars and has already demonstrated resilience through the war.
The medium-term outcome depends on the coalition shape. A broad unity government that excludes the far right would likely be read as institutional-stability positive and could bring the currency back toward the stronger end of JPMorgan's range. A narrow right-wing minority government dependent on ad hoc support would keep the risk premium elevated and leave fiscal discipline as the first casualty. A fifth election is the downside case: it extends uncertainty into 2027 and forces the central bank to keep defending the currency while financing a war deficit.
Longer term, the structural question is whether any government can reverse the re-rating of Israel's sovereign risk. That requires more than political stability; it requires a credible answer to the deficit, and no bloc in the current Knesset has campaigned on the spending cuts or revenue measures that would deliver one.
Data as of October 30, 2026. Election seat counts are final results published October 29; fiscal and market figures are drawn from central-bank forecasts and market data available as of this report.
The election settled how Israelis voted. It did not settle who will govern them — and until that question is answered, the market will keep charging a premium for the privilege of waiting.
Explore more exclusive insights at nextfin.ai.
