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It’s going to be an El Niño summer, probably. The National Oceanic and Atmospheric Administration is predicting a warming phase in the tropical Pacific Ocean by July with near certainty, and about a one-in-three chance that it’ll grow to “very strong” intensity:
Meanwhile, various forecasters are warning of potentially the most violent El Niño-Southern Oscillation on record.
At a time when food prices are surging, the threat of floods and droughts wiping harvests sounds bad, though it may not be as bad as it sounds. Alan Beattie’s Trade Secrets newsletter last week was all about how El Niño doesn’t deserve its fearsome reputation.
Local damage doesn’t usually feed global inflation when properly managed, writes Beattie, who notes that none of the postwar inflationary spikes cannot be blamed solely on weather. The most severe episode in the last half-century, the ill winds of 1972-73, coincided with an Arab countries’ oil embargo and a failure of central banks to keep a lid on wage demands:
Policymakers’ greater credibility during subsequent decades meant the world economy could ride El Niños and other shocks to commodity prices without setting off generalised inflation. Certainly, the weather system still causes localised food shortages, particularly in low-income net-importing countries, which can be devastating. But since the 1970s, the correlation between it and global food inflation has been weak.
Highlighting the resilience of global trade isn’t to deny that regional damage can be devastating, however. El Niño is particularly hard on countries where agriculture and fishing are big employers; where not enough has been spent on flood defences; and where farms tend to cultivate climate-sensitive crops like bananas, cocoa, and shrimp:
Because intensity is what really matters, Noaa’s May update was a step-change from April that needs investors’ attention, says JPMorgan analyst Diego Pereira:
While moderate, strong, and very strong scenarios remain broadly evenly distributed in probabilistic terms, the balance of risks has tilted meaningfully. The probability mass no longer concentrated in benign outcomes; instead, there is a growing likelihood that the event reaches at least strong intensity, with tail risks — including outcomes comparable to 1997–98 or 2015–16 — remaining small but non-negligible.
Noaa forecasts this year’s event to peak in the three-month window beginning in November, with a so-called Kraken El Niño rated the most likely scenario on a probability of 37 per cent. The chance of a strong-or-more event was upgraded over the past month from 51 per cent to 67 per cent, while the odds on anything less have collapsed.
Having changed quickly, the picture could change again. Forecast ranges remain wide, and there’s a lot of guesswork involved when divining the feedback loops that cause an ocean to heat and cool. Still, based on the current data, the question for investors is now how strong El Niño will become, Pereira tells clients:
Historically, the difference between a moderate and a strong El Niño is not linear: impacts on global food prices, agricultural output, and energy dynamics tend to accelerate once temperature anomalies breach the +1.0°C threshold. As such, even a modest upward revision in the probability of stronger events can have disproportionately large implications for inflation dynamics, terms of trade, and policy responses across emerging markets. [ . . . ]
As probabilities continue to migrate toward stronger outcomes, the focus should increasingly turn to second-order effects: the potential for synchronized price shocks, supply disruptions, and policy trade-offs that tend to accompany more forceful El Niño episodes.
Economic effects are amplified by storm intensity, meaning linear models understate both the risks and the policy challenge, says JPMorgan. Its own modelling suggests a Kraken El Niño could “produce a material and region-wide inflation shock, with peak effects emerging over the second half of the year.”
Per the charts at the top of the page, El Niño risks and rewards are unevenly distributed.
Rain in Argentina’s Pampas region can improve its soyabean, corn, and wheat yields, boosting tax receipts and bringing in much-needed dollars to prop up the peso. Farmers in Uruguay and Chile might also welcome the rain, though any benefit would be undone if storms strong enough to damage mining and ports infrastructure. Paraguay is another relative winner thanks to its hydropower industry.
Previous El Niño episodes have been inflationary for Brazil due to floods in the agricultural south and drought in the north, where most of its hydroelectric dams are sited.
Peru looks beleaguered already, having in February declared a state of emergency over much of the country due to landslides and flooding. Ecuador has a coastal arable economy similar to Peru’s, and its adoption of the US dollar as official currency means it can’t inflate away a crisis, though its oil and hydroelectric production are offsets. Colombia’s ombishambolic economy is acutely exposed to drought through hydropower and coffee.
We’ll note only in passing that drought in India could severely reduce global sugar supply; strong Harmattan winds might harm West African cocoa plantations; flooding risk rises across the southern US and Central America; and a dry spell might affect rice yields in Thailand, Pakistan, Indonesia, and the Philippines. There’s a lot going on:
Here, from Citi, is a chart of soft commodities by implied El Niño and Strait of Hormuz exposure. Enlarge to read the explainer in the small print.
Inflation pressures peak between four and eight months after El Niño’s first hit, so whatever the effects are, they will be felt towards the end of the year and into 2027, Pereira says. That heaps pressure on central banks to keep tightening:
The central message is straightforward. El Niño is not a binary event; it is a spectrum, and the macroeconomic consequences depend critically on where along that spectrum the economy lands. A mild episode would be manageable. A strong or very strong El Niño, by contrast, would generate a meaningful inflation shock across Latin America, with the largest effects concentrated in the Andean region and more persistent dynamics in Brazil.
