El Niño – a weather phenomenon that has caused as much as $84 trillion in global economic damage since 20001 – is shaping up for a potentially devastating season. As a new El Niño gains strength, local governments are watching for potential effects on their communities. Investors are paying attention too, as weather patterns associated with El Niño could affect commodity production, markets and economies.
It is one of the few climate events with a truly global reach. In North America, El Niño typically brings milder winters to the northern U.S. and stormier conditions to the southern states and Gulf of Mexico. South America generally experiences heavier rainfall, while Indonesia, Australia and southern Asia could face droughts.
The U.S. National Oceanic and Atmospheric Administration (NOAA), which forecasts weather and monitors the global climate, sees an 81% chance of this year’s El Niño becoming a very strong event.
“Most El Niño years are a nuisance, but this one has the makings of a shock, and as weather patterns shift across key growing regions, the effects may extend far beyond local forecasts and into supply chains, prices and investment returns,” says Julia Rizzo, Morgan Stanley Research Equity Analyst and Commodities Strategist for Latin America.
Uneven Impacts for Agriculture
NOAA’s models indicate that El Niño conditions are expected to peak from December through February, coinciding with the main planting and crop-development period in South America.
Wetter conditions could benefit agricultural yields in Argentina and southern Brazil, while other regions of Brazil face a greater risk of irregular rainfall and delayed soybean planting.
“As a result, a super-bullish grain price scenario appears less likely, especially considering that El Niño events have historically coincided with weaker grain prices,” Rizzo says.
Morgan Stanley Research finds that sugar is the agricultural commodity most likely to get a price boost from El Niño. Weaker monsoon rainfall could cut sugar-cane production in India, Thailand and Southeast Asia, while heavier rainfall in Brazil could reduce yields there.
West Africa grows most of the world’s cocoa, chocolate’s main ingredient, and output there could suffer too — first from wet-season disease between June and October, then from the dry, dusty Harmattan winds.
“El Niño is more relevant as a regional earnings and positioning question than as a broad directional trade,” Rizzo says. “Crop timing, geographic exposure and operating flexibility will determine where weather translates into lower volumes, higher costs or stronger prices.”
El Niño’s Long Tail
Historically, El Niño has had little bearing on global asset prices, with some exceptions in commodity markets. But a “super” event—depending on its timing and duration—could break that pattern. Lower agricultural output could add to inflationary pressures, with potential consequences for economies and financial markets.
“We expect copper and emerging-market sovereign credits to be the most structurally exposed to a ‘super’ event,” says Morgan Stanley Research Cross-Asset Strategist Erika Singh-Cundy. “Given these risks, along with headwinds from energy prices, we maintain our preference for developed-market over emerging-market risk assets.”
Here are Morgan Stanley Research’s views on El Niño’s impact across asset classes:
Metals: Copper output could face disruptions, potentially leading to higher prices. In Chile, the world’s largest copper producer, wetter weather and flooding could pose risks to mining infrastructure. Drought in Zambia, which accounts for 4% of global copper production, could cause hydropower shortages, affecting output.
Credit: In debt markets, El Niño could pose risks to sovereign credit in parts of Latin America and Africa, with impacts varying widely by country: droughts threaten agriculture and hydropower, while heavy rains can damage infrastructure or, in some cases, boost harvests. Higher food prices add lagged inflationary risk. Sovereigns with more fiscal capacity and external buffers should be better insulated. Ecuador, Mozambique, Zambia, Colombia, Costa Rica, and Peru are likely to be the most exposed, while Chile, Uruguay and Argentina could benefit.
Local rates: Within Latin America, El Niño poses the greatest risk to local rates in Brazil, Colombia and Peru via higher inflationary pressures. While their central banks are likely to look past initial food-price shocks, second-round effects could delay easing cycles or keep rates restrictive for longer.
FX: Latin American currencies could experience more volatility. Higher inflation and interest rates would support local currencies, but weaker growth and uncertainty about the inflation outlook could weigh on them.
Equities: The impact of El Niño is likely to vary by sector. Higher soft-commodity prices would benefit sugar producers and agricultural-input suppliers—including companies providing seeds, fertilizers, chemicals and equipment—as well as the Latin American power sector and scaled U.S. food retailers and discounters. However, companies that buy higher-priced crops, including Brazilian chicken and protein producers, could face pressure.
