Deutsche Bank and The Terrors of El Niño

Current forecasts are pointing to one of the strongest El Niño events on record in Q4. Food prices are predicted to rise. Energy bills? Also projected to spike. On top of this, broader supply-chain disruption is expected. But what actually is El Niño, and why are the consequences estimated to be so disruptive this time around?

El Niño is a naturally occurring event that takes place in the Pacific Ocean every 2-7 years on average, whereby there are unusually warm sea surface temperatures in the eastern Pacific. Normally, trade winds blow east to west across the Pacific, piling up warm water near Indonesia and Australia. This warm water drives up the level of moist air in these regions, bringing about a rise in evaporation and rain levels. On the flipside, the eastern Pacific is void of such levels of rain.

However, during El Niño events, trade winds weaken and do not push warm water westwards, meaning warm water and subsequent rain builds up in the eastern Pacific. In the US, El Niño normally coincided with wetter conditions, particularly along the Gulf Coast. Stronger episodes see this extend to California and the Southwest too. But in other regions, it is more likely to cause droughts as is the case in Australia, whilst nations like India see weaker monsoon rains.

This effect can also be seen with global temperatures – record levels have coincided with El Niño events in 1998, 2016 and 2024. Unfortunately, El Niño events are correlated with a higher frequency of natural disasters. Flooding in particular sees a stark rise, though this can also be attributed to temperature changes too (the recent flooding in Nepal is not a consequence of El Niño). The spread of climate-sensitive diseases is another major consequence – the 2015 El Niño event contributed to the spread of the Zika virus, since it created conditions beneficial for mosquito-borne transmission.

This bring us to the question: what’s particularly bad about this El Niño? Since 1952, there have been 28 El Niño events, with 4 being branded as ‘very strong’ as per the Oceanic Niño Index. The US Climate Prediction Centre have said that this could be one of the strongest such events in over 75 years, with an 81% chance of it reaching the ‘very strong’ threshold of 2C over October to December.

A very strong El Niño means it’s more likely to shift rainfall and temperature patterns across multiple regions simultaneously, providing a substantially greater level of risk. The timing of this event further adds to its threat. The global economy is already facing a significant supply-chain stress, most notably due to the closure of the Strait of Hormuz, with oil and gas prices skyrocketing.

The most recent El Niño event between 2023-24 offers insight into what might happen. 2024 was the warmest year on record with severe droughts in parts of South America and severe flooding in East Africa and South America. Meanwhile, the Panama Canal had its 3rd driest year on record in 2023, meaning authorities had to cut shipping passing through, raising shipping costs and global delivery times. Rather concerningly, despite its effects, the last El Niño was not even considered ‘very strong’.

So what role does Deutsche Bank play in all of this? Deutsche Bank have formulated a multi-chain transmission mechanism to explain the potential effects of the upcoming El Niño event upon the global economy and markets attributed to the following: food supply, energy and hydropower, shipping/supply chains, emerging market vulnerability and social/political unrest.

Starting with food supply, Deutsche Bank explains that the shifting rainfall patterns can cause damage to crops, kill livestock and lead to disruption in the food production process. The impact of these food shocks is varied across different economies. In the US, for instance, food-at-home makes up just 8% of the consumer basket for CPI inflation. On the other hand, in several emerging market economies, over a third of household expenditure is on food. Consequently, emerging markets such as India and Indonesia are among those severely affected.

Moreover, food inflation is a problematic category because it’s a necessity, preventing easy substitution seen with things such as luxury goods. Beyond this immediate impact, Deutsche Bank also highlights second-round inflationary effects. Many governments often react to El Niño events by using subsidies to cushion the impact of higher food prices. Whilst this does reduce the domestic hit (albeit temporarily), it also pushes the adjustment elsewhere and risks creating further cost of living crises via long-term contractionary fiscal policy.

Deutsche Bank also focuses on the impacts of El Niño events upon energy and hydropower. Due to a fall in rainfall in the western Pacific, these regions see less electricity generated from hydro-electric dams, Moreover, the droughts brought about compound the misfortune of cuts in electricity generation as the demand for cooling and need for water for irrigation rise. A fall in hydropower output is said to force a shift to other forms of energy, such as petrol, lifting global power prices.

The Bulge Bracket firm then denotes shipping/supply chains to be another major consequence of El Niño events, as evidenced by the 23/24 El Niño in Panama, where rainfall levels falling to around 30% below average forced authorities to restrict the number if ships passing through a point covering around 5% of then global maritime trade. Any supply chain issues are particularly troublesome in the present because the Strait of Hormuz has seen traffic almost completely cease altogether. A rise in transit points disrupted is thus said to only heighten shipping rates and delivery times.

Deutsche Bank’s penultimate transmission channel is the vulnerability of emerging market countries. By virtue of their geographic position, emerging markets are much more likely to face the impact of flooding or drought associated with El Niño. This, in tandem with their increased exposure to food prices, suggests that the upcoming El Niño event is a far greater threat to emerging markets. This vulnerability may incite central banks to raise interest rates so as to control inflationary expectations, which Deutsche Bank believes will do little to solve the actual supply shocks at hand. Moreover, fiscal policy’s usage will shift the shock onto public balance sheets, heightening the issue of sovereign risk.

Finally, Deutsche Bank references the impacts of El Niño events on social/political unrest. Throughout history, higher food prices have often correlated with political unrest. If El Niño leads to higher food prices and squeezes disposable income that much more, unrest is much more likely. In 2010-11, higher food prices were regarded as a contributing factor behind the Arab Spring and more recently, in 2022, price shocks contributed to protests in Ecuador, Sierra Leone, Haiti and Panama.

Ultimately, a very strong El Niño event would be another negative supply shock in a time where the global economy has little room to absorb one. The combination of higher food and energy prices will mechanically raise inflation, and broader supply-chain distribution risks can create further pressures on top of the Strait of Hormuz’s blockage. These problems could develop into leaving inflationary expectations unanchored if prices become disruptive over a prolonged period, potentially creating an enhanced wage-price spiral in affected regions. Given the forecasts for the strength of this El Niño, this will be an important event to look out for over the months ahead.