Brace yourself, we're about to be hit by what could be the mother of all supply shocks. A Super El Niño brewing in the Pacific could further disrupt supply chains and hike inflation when the world is already vulnerable. Henry Allen, macro strategist with Deutsche Bank Research Institute, warns that El Niño events can act as a multi-dimensional supply shock, with a causal link to higher food and energy prices, alongside broader supply-chain disruption. This is particularly problematic now, as the Iran war has already disrupted supply chains and pushed up inflation by blocking the Strait of Hormuz. A very strong El Niño event would be another negative supply shock, at a point when the global economy has limited room to absorb one. El Niños happen when unusually warm sea surface temperatures in the eastern Pacific Ocean change the course of jet streams and weather patterns. They are characterized by higher global temperatures and a higher frequency of natural disasters ranging from flooding in North America to drought in Australia and Asia. For markets, an El Niño is capable of hitting agricultural production, hydropower, shipping, and even has effects on public health and political stability. In other words, it operates as a multi-channel supply shock. Though El Niño cycles repeat every few years, forecasts are predicting that this one will rank among the most serious in recent history. The U.S. Climate Prediction Centre warned this event could be one of the strongest in 75 years with a high chance it reaches "strong" thresholds in July to September and "very strong" in October to December. A "very strong" El Niño is capable of shifting rainfall and temperature patterns over multiple regions at the same time. This drives up food prices by damaging crops, killing livestock and disrupting shipping. Lower rainfall in some regions can impede the electricity generation of hydroelectric dams as higher temperatures raise the demand for power. El Niños also disrupt supply chains. In the last event in 2023-24, a 30 per cent drop in rainfall forced the restriction of ships passing through the Panama Canal. The combination of higher food and energy prices threatens to ramp up inflation already under pressure from the closure of the Strait of Hormuz in the ongoing Iran conflict, said Allen. Conditions today are reminiscent of the 1970s, when a series of unrelated supply shocks, including an El Niño, kept inflation high. Even though the shocks themselves were temporary, their frequency caused inflation expectations to become entrenched and policymakers were forced to react. Given the forecasts for the strength of this El Niño, this will be an important event to look out for over the months ahead.
