Why the 2026 Super El Niño Matters Mainly Through Inflation

The 2026 Super El Niño has captured the attention of investors due to its potential impact on inflation. While El Niño is often associated with weather-related events like droughts, floods, and storms, its true significance lies in the disruption it causes in economically important areas. A storm in a remote region may have different consequences compared to the same storm passing through a major city, where infrastructure damage and economic disruption can be amplified.

The concern with this particular El Niño is that it could add another layer of inflationary pressure to an economy already grappling with rising food, energy, and other costs. Inflation is already on the rise, and another shock from food, energy, fertiliser, and reconstruction costs could complicate efforts to resolve the existing problems.

One of the clearest channels through which El Niño could impact inflation is food prices. Historically, severe El Niño events have been linked to global food price increases of up to 5%. Moreover, agriculture faces additional pressures, such as higher oil and fertiliser costs and disruptions resulting from conflicts. The supply of fertiliser, a crucial input for agriculture, is concentrated in the Middle East, which could further exacerbate the situation.

Beyond the immediate food supply, reconstruction efforts following a major disaster can also contribute to inflationary pressures. Infrastructure damage, including electricity networks, transformers, roads, and homes, can strain construction resources. This competition for labour, machinery, and electrical equipment can drive up prices even further. The rebuilding process may create demand even when supply is already constrained, potentially leading to higher costs across various sectors.

Insurance companies are particularly vulnerable during extreme weather events. More frequent bushfires, floods, hurricanes, or typhoons can result in increased claims, and Australia, for instance, could face higher bushfire-related losses during a severe El Niño. However, insurers' vulnerability is not solely negative. After a major disaster, premiums can be raised, offsetting some of the losses from claims.

Additionally, insurers hold large bond portfolios, and if high inflation weakens conventional bond prices, insurers may face pressure from both sides.

The relationship between insurers and the broader economy becomes complex during periods of heavy claims. Initially, insurers may struggle, but the subsequent rise in premiums can create opportunities for future profitability if another major disaster does not immediately follow. However, the timing and location of future disasters remain uncertain, making it challenging to predict the exact impact on insurers.

The "stimulus paradox" is an intriguing concept in this context. While a natural disaster destroys wealth and productive capacity, the subsequent reconstruction efforts can generate economic activity. Governments allocate funds to repair infrastructure, insurers provide resources for rebuilding, and construction companies receive new work.

This cycle may seem to boost economic activity, but it is essential to recognize that much of the spending is simply replacing what has already been destroyed. Investors should focus on understanding how the money is allocated, which sectors benefit, and whether the demand for reconstruction arrives when supply is already constrained.

Commodities present another challenge for investors during an El Niño event. If the weather disrupts production, prices for crops or raw materials could rise. While this may seem like an opportunity to invest in commodity producers, it is crucial to consider the specific circumstances. A company whose assets are unaffected by the disruption may benefit from higher prices, while a company whose own production is damaged may struggle despite the increased commodity prices.

Therefore, investors should closely examine the location of a company's assets and assess whether they benefit from someone else's supply shortage or suffer from losses in their own production.