Dawid Heyl, Natural Resources Portfolio Manager & Nicolas Jaquier, Emerging Market Fixed Income Portfolio Manager; at Ninety One
Geopolitical events are squarely to blame for the energy supply disruption and associated inflationary pressure seen this year. Now, with another inflation risk beginning to emerge, weather joins the list of culprits for a challenging backdrop facing policymakers and investors alike.
Meteorologists are monitoring conditions that could develop into a prolonged El Niño event with potential for a profound and widespread impact.
Rather than triggering a single global inflation shock, a prolonged El Niño could create overlapping pressures across agricultural production and fertiliser and energy markets. It follows that the ultimate impact is unlikely to be uniform and El Niño could prove particularly challenging for more vulnerable economies this year.
Historical evidence suggests these risks are not merely theoretical. IMF research has found that El Niño has historically accounted for around one-fifth of movements in global commodity price inflation, with previous episodes contributing to higher food and energy prices as weather disruptions ripple through supply chains. The effects have typically been most pronounced in economies where food accounts for a larger share of household spending, highlighting why emerging markets are unlikely to experience the impacts equally. Dawid Heyl, Natural Resources Portfolio Manager: “The biggest misconception about El Niño is that it affects the world equally. It doesn’t. The impact is highly regional, and that’s where investors should be focusing their attention.”
The effects are unlikely to be felt equally across regions. El Niño has historically had its greatest impact on parts of Southeast Asia, India and Australia, while many major agricultural producing regions, including the US Midwest and Western Europe, are relatively less exposed.
A prolonged El Niño event could disrupt production across key agricultural commodities including rice, wheat, palm oil and pulses, increasing food price pressures. While global inventories appear relatively healthy in absolute terms, stocks relative to demand are considerably tighter than headline figures suggest, leaving markets more sensitive to production disappointments.
“The duration of the event may prove more important than the headline intensity. If conditions persist into next year, the risk of meaningful disruption to agricultural systems increases significantly,” said Heyl.
The inflationary implications may also extend beyond agricultural commodities. Lower hydroelectric generation amid drier conditions, combined with higher electricity demand during hotter weather, could increase reliance on alternative energy sources such as natural gas, creating an additional source of inflationary pressure.
The extent of disruption on individual emerging markets is likely to depend on a variety of factors.
Nicolas Jaquier, Emerging Market Fixed Income Portfolio Manager: “There isn’t a one-size-fits-all outcome. Some emerging markets have spent years establishing credible policy frameworks that have helped to strengthen macroeconomic buffers such as FX reserves. Central banks that have done the hard work in this regard may be able to look through temporary food price shocks; others remain significantly more vulnerable.”
In addition to assessing the relative resilience of economies, Jaquier believes investors should focus on the interaction between multiple risks.
Jaquier noted: “The bigger concern is when shocks begin to overlap. If higher energy prices coincide with fertiliser constraints and then weather-related food inflation, the impact becomes broader and more persistent than any one shock on its own.”
The uncertainty surrounding both the timing and severity of El Niño also makes it difficult for investors to position portfolios in advance. For investors, the implications are unlikely to be uniform. Colombia, for example, has historically faced drought conditions during El Niño episodes, increasing pressure on hydroelectric generation, food prices and inflation. By contrast, Argentina has often benefited from improved rainfall, supporting agricultural output and export earnings. These contrasting outcomes illustrate why careful country selection is likely to matter more than broad regional positioning.
“Markets struggle to price El Niño because the timing is inherently uncertain,” Jaquier said. “The challenge is not knowing whether inflationary pressures emerge in a few months’ time or much later, making careful country selection increasingly important.”
For investors, climate events are increasingly becoming macroeconomic events. Their effects extend well beyond agricultural production, influencing inflation and therefore monetary policy and bond market returns. Understanding which countries have the resilience to absorb temporary shocks and which remain more exposed may prove just as important as tracking the weather itself.
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