El Niño returns: From climate signal to sovereign risk

This work draws on our ongoing research collaboration with Johns Hopkins University's Earth and Planetary Sciences and Civil and Systems Engineering departments, as part of our broader effort to further incorporate financially material physical climate considerations into our proprietary sovereign macroeconomic research, responsible investing analysis, issuer engagement, and investment process.

March 2023 brought an extreme coastal El Niño in the far eastern Pacific off Peru and Ecuador. This localized coastal event was distinct from the broader basin-wide El Niño that developed later in 2023. It flooded parts of northern Peru, damaging infrastructure and disrupting agriculture, fisheries, and other economic activity. The macroeconomic effect was material, but Peru’s low public debt, substantial international reserves, and established policy frameworks provided buffers against a more severe sovereign financing shock. The episode illustrated that significant physical and economic damage does not necessarily translate proportionately into sovereign market stress.

The data suggest that El Niño is already underway and strengthening, with a high probability of a very strong event later in 2026. The duration of the event and its regional weather impacts remain uncertain. For sovereign investors, the key question is how these shocks could propagate through food and power systems, inflation, fiscal accounts, and external balances, and whether individual countries have sufficient buffers to absorb them. Importantly, the economic consequences of El Niño are highly uneven. Severe weather events may be manageable in one country but generate significant inflationary, fiscal, or external pressure in another.

The risks may be amplified because this cycle follows successive shocks to public finances, supply chains, and food and energy markets, including the pandemic, Russia’s invasion of Ukraine, and more recent geopolitical disruption in the Middle East. Many sovereigns now face higher debt‑servicing burdens and less fiscal flexibility, increasing the fiscal and policy cost of responding to renewed food and energy inflation.

The evidence base linking El Niño‑related climate shocks to sovereign markets is emerging but remains geographically limited and less mature than the broader literature linking climate and weather shocks to macroeconomic outcomes. The nature and severity of weather impacts can vary substantially across countries. For sovereign investors, the key question is which El Niño transmission channels are likely to prove most financially material, including through food inflation, hydropower and energy stress, weaker growth, and deteriorating fiscal and external balances. Persistent inflationary pressures may delay monetary easing or necessitate additional policy tightening, while political or social pressures may also rise.

T. Rowe Price and Johns Hopkins University have established an ongoing research collaboration to incorporate financially material physical climate science into sovereign analysis. The current phase of the research examines how different El Niño-Southern Oscillation (ENSO) states influence temperature, precipitation, hydrology, and agriculture across an initial group of 12 priority sovereigns identified by T. Rowe Price. T. Rowe Price and Johns Hopkins University jointly assess how those physical signals could transmit through macroeconomic fundamentals, fiscal and external balances, policy responses, institutional resilience, and market pricing. Together, we believe that this work will continue to provide important input into country‑level sovereign research across credit, local rates, and currencies.¹

What is ENSO and why could this cycle matter?

ENSO is a recurring fluctuation in sea‑surface temperatures and atmospheric pressure across the equatorial Pacific. El Niño is the warm phase and La Niña the cool phase. ENSO can alter the odds of drought, flooding, extreme heat, and different storm patterns across every continent.

El Niño events recur at irregular intervals, typically every two to seven years.² They often begin developing during the Northern Hemisphere spring or summer, strengthen through the autumn, and peak between November and January. The magnitude of El Niño events can vary considerably. A very strong El Niño is relatively rare. Such events are sometimes referred to as “super El Niño” in popular commentary, although this is not a standardized scientific classification. A very strong event is characterized by sea surface temperatures in a key region of the tropical Pacific, known as the Niño 3.4 region, reaching at least 2°C above average over a three-month period.

A very strong El Niño does not automatically mean a larger economic shock

As of August 13, 2026, El Niño was strengthening, with the National Oceanic and Atmospheric Administration (NOAA) assigning a greater than 90% probability to a very strong event during the Northern Hemisphere autumn and winter. NOAA’s August strength forecast assigned a 95% probability to a very strong event during October to December and a 90% probability during November to January (see Figure 1). While stronger events increase the likelihood of some characteristic El Niño impacts, they do not determine the severity of local weather or economic outcomes. We therefore treat even a very strong El Niño as a risk scenario, not shorthand for a uniformly severe weather, economic, or market shock.

From climate signal to sovereign risk

For sovereign investors, the weather event is only the first step. El Niño does not change country risk directly. Rather, it changes the probability distribution of investment outcomes by altering the likelihood of weather shocks that may or may not transmit through the economy. El Niño climate shocks can cascade through food, energy, fiscal, external, and political transmission channels, as seen in Figure 2. This cascade has the potential to produce materially different economic and financial outcomes depending on each country’s structural vulnerabilities and policy buffers. For example, drought has the potential to reduce crop output and reservoir inflows while flooding can damage transport links and other infrastructure, and warmer coastal waters can disrupt fisheries.

The magnitude and timing of these effects are crucial. The financial impact emerges when the physical effects pass through to food and electricity prices, economic activity, trade, public finances, and policy credibility, and then into local rates, currencies, and hard‑currency debt.

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Cocoa illustrates how climate exposure could become financial risk

The transmission framework illustrated in Figure 2 can be seen in agricultural commodity markets. El Niño can increase the risk of weaker cocoa production in West Africa, but it does not automatically imply another 2023/24‑style price shock. The outcome will depend on realized rainfall, disease, pod development, and crop arrivals, as well as inventories, demand, and the ability of supply elsewhere to offset any shortfall. Compared with 2023/24, the current cocoa market may enter this El Niño cycle with a somewhat stronger starting position. However, whether that translates into greater resilience will depend on realized production, crop arrivals, inventories, grindings, and demand, rather than the El Niño signal itself.

For cocoa-exporting sovereigns, weaker production could reduce export earnings, foreign‑exchange availability, fiscal revenues and rural incomes, although higher cocoa prices may partly offset lower volumes. For corporate issuers, procurement and hedging can delay the impact on margins and cash flow. The investment question is therefore whether adverse crop conditions become sufficiently severe and persistent to weaken these buffers and transmit the climate shock into sovereign fundamentals and market pricing across sovereign debt, local rates, and currencies.

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Why country outcomes differ

Exposure to El Niño can indicate where drought, flooding, and other physical effects may occur. Sovereign vulnerability depends on whether those physical effects reach inflation, growth, fiscal and external accounts, and policy credibility—and whether the country has sufficient buffers to absorb them.

Countries with high food consumer price index (CPI) weights, substantial hydropower dependence, climate‑sensitive export sectors, limited fiscal flexibility, or weak external buffers may be particularly vulnerable to stagflationary dynamics, in which inflation rises while growth weakens.

Hydropower disruption could be an especially important transmission channel during the current El Niño cycle, given the heavy reliance on hydroelectricity across several emerging markets. Hydropower accounts for a significant share of electricity generation in Zambia, Colombia, Brazil, and Vietnam. Prolonged drought can reduce power supply while increasing reliance on thermal generation and imported fuel, adding to electricity prices, external financing needs, and fiscal pressures.

Building on our work with Johns Hopkins University, acute ENSO impacts are highly heterogeneous with outcomes shaped by country-specific vulnerabilities. We assess ENSO vulnerability through three linked questions:

• Where is the economy structurally exposed? This includes the importance of climate‑sensitive sectors, food prices in the inflation basket, hydropower reliance, and commodity export concentration.
• How could the shock pass through the economy? Key factors include dependence on imported food and energy, external financing requirements, and the potential effects on inflation, growth, fiscal accounts, and the external balance.
• How much capacity does the sovereign have to absorb it? Relevant buffers include foreign exchange reserves, fiscal space, policy credibility, central‑bank independence, infrastructure resilience, and disaster preparedness.

The 2023/24 cycle illustrates different forms of resilience. Peru experienced substantial disruption to fisheries, agriculture, infrastructure, and other activity, but strong financial buffers and credible macro policies in place reduced the risk that these effects would become a sovereign financing shock. Indonesia faced food price pressure, but rice imports, logistics, and active supply management helped moderate the domestic inflation transmission. The cases therefore highlight different buffers: Balance sheet and policy credibility in Peru, and food security and supply management in Indonesia.

Zambia was more vulnerable because several channels overlapped. Drought affected rain‑fed agriculture and hydropower simultaneously, materially reducing available electricity. The effects were uneven: Electricity access was prioritized for mining and larger power users, while households and smaller businesses absorbed a greater share of the load shedding. The resulting power shortages weakened activity and contributed to inflationary and fiscal pressures.

The implications are not uniformly negative. Our collaborative research with Johns Hopkins University has highlighted that some countries may benefit on a relative basis from improved agricultural conditions, lower winter heating demand, or stronger commodity export pricing. We believe assessing ENSO risk therefore requires a country‑specific view.

From climate probabilities to sovereign vulnerability

As part of the research collaboration, Johns Hopkins University has developed a teleconnection model drawing on historical climate data (see Figure 3 for an illustrative example of the model). The model estimates how the probability of climate variables such as above- or below-normal temperature and precipitation has varied by country, subregion, and season during previous El Niño events. The results do not predict the realized weather outcome of any individual cycle. Instead, they help analysts identify where particular physical risks may warrant closer investigation. T. Rowe Price’s sovereign analysts can then assess how those climate conditions might interact with each country’s economic structure and policy buffers.

Where risks may be most financially material

The following case studies illustrate how broadly similar climate exposure can raise different investment questions, depending on a country’s economic structure and the strength of its policy response.

Colombia
Food and hydropower in the same shock

• El Niño‑related drought can reduce agricultural output and reservoir levels. With hydropower supplying a large share of Colombia’s electricity, lower reservoir levels may increase reliance on higher‑cost thermal generation, adding to electricity costs and food‑price pressures.
• During the 2023/24 cycle, reservoir levels fell sharply, but the electricity system continued to meet demand. Additional generation capacity, thermal generation, and wider system management measures helped limit disruption.
• Key takeaway for investors: For the 2023/24 cycle, infrastructure resilience and energy‑system flexibility materially reduced sovereign stress relative to earlier fears. For investors today, the key question is whether lower reservoir levels would materially alter inflation, the central‑bank path, and the currency outlook—or become severe enough to affect fiscal and sovereign credit fundamentals. The degree of preparedness will depend on Colombia’s starting reservoir levels, gas availability, grid flexibility, and the approach to tariffs and utility support.

Indonesia and the Philippines
Why similar exposure can produce different outcomes

• Indonesia and the Philippines can both face food‑supply pressure during El Niño, but their capacity to absorb it differs. During the 2023/24 El Niño, Indonesia used rice imports, improved logistics and active supply management to moderate domestic food price pressures. The Philippines experienced greater food inflation pressure, reflecting its sensitivity to rice prices and imported food and fuel.
• Today, the Philippines appears more exposed because of its dependence on imported food and fuel, the importance of rice from a Consumer Price Index (CPI) perspective, and more limited fiscal buffers. These factors can produce stronger inflation and pressure on the currency during an El Niño-induced food shortage, potentially requiring the central bank to hike interest rates.
• Key takeaway for investors: Food‑security buffers, logistics, and trade policy can materially affect inflation pass‑through. These differences may lead to contrasting assessments of monetary‑policy flexibility, currencies, and sovereign risk even when countries face broadly similar climate exposure. Preparedness will depend partly on rice stocks, logistics capacity, subsidy policy, and central‑bank credibility.

What does this mean for investors?

Beyond the teleconnection analysis shown in Fig. 3, the research also examines soil moisture, runoff, streamflow, and crop‑weighted exposure.³ Together, these tools can help identify where a developing event deserves attention.

The ENSO outlook must then be mapped onto the relevant economy. This includes identifying which crops, reservoirs, power assets, and transport routes lie in affected areas; how dependent the country is on imported food and fuel; how concentrated its export earnings are; and which fiscal or quasi‑fiscal mechanism may absorb the cost. Subnational analysis is important because national averages can conceal concentrated exposure in agriculture, mining, or hydropower.

Building on the initial 12-country phase, the research is expanding to incorporate other climate-exposed sovereigns while considering many important cross‑country economic linkages. As climate teleconnections and macroeconomic relationships evolve over time, the analysis is updated as new climate and economic data become available rather than assuming historical relationships remain constant.⁴

While the partnership continues to evolve, initial work has already informed analysts and portfolio managers in navigating sovereign risk. The climate and macroeconomic models help to assess the possible direction, timing, and magnitude of an ENSO‑related scenario. Their outputs are considered alongside realized weather and macroeconomic data, central‑bank reaction functions, other policy responses, foreign exchange reserves, fiscal capacity, institutional strength, and market valuation to inform investment risks and opportunities.

Research in practice

Drawing on analysis of the 2023/24 El Niño cycle, T. Rowe Price’s sovereign analysts have incorporated the research into country‑level assessments across sovereign credit, local rates, and currencies. The climate analysis formed part of the broader emerging markets sovereign investment process, helping analysts evaluate how physical climate risks could affect sovereign fundamentals and relative value across countries. The research also informed discussions with institutional clients on the potential implications of climate‑related risks for sovereign bond portfolios.

In one sovereign market, the analysis shifted attention from national rainfall averages to reservoir conditions in the principal hydropower region, prompting analysts to widen the range of inflation scenarios after identifying a greater risk of electricity shortages and higher power costs. Beyond inflation, lower reservoir levels could also disrupt energy‑intensive sectors such as mining, reducing production, export receipts, fiscal revenues, and economic activity, thereby creating an additional transmission channel to sovereign credit risk.

From scenarios to market implications

Used carefully, we believe ENSO analysis could help investors separate countries that share physical exposure but differ in transmission, buffers, and market pricing.

The analysis can be updated as realized weather, crop, reservoir, and power data emerge, and as those effects begin, or fail, to reach macroeconomic fundamentals. Investors can then assess the policy response and consider whether current market pricing adequately reflects the evolving scenario.

What to watch next

The 2026/27 El Niño could become a material macroeconomic and market event, but the outcome will depend on geography, timing, and intensity, alongside each country’s starting conditions and capacity to respond. Soil moisture, crop development, reservoir levels, food and electricity inflation, and policy decisions will show whether the climate signal is beginning to reach sovereign fundamentals, and ultimately affect market pricing.

The value of the research lies in bringing more granular climate and hydrological evidence into country‑level sovereign analysis, helping identify where physical disruption may become financially material, which countries have the capacity to absorb it, and whether markets compensate investors for the risk.

Exposure is not the same as vulnerability, and vulnerability is not necessarily the same as mispricing. Even where an ENSO shock weakens fundamentals, the investment conclusion depends on whether local rates, currencies, or sovereign spreads already compensate investors for that risk. As the 2026/27 El Niño event evolves, new data will provide an opportunity to test and refine those scenarios.