CONTRIBUTORS

Nicholas Hardingham, CFA
Portfolio Manager, Franklin Templeton Fixed Income

Stephanie Ouwendijk, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income

Robert Nelson, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income

Joanna Woods, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income

Sterling Horne, Ph.D
Research Analyst,
Franklin Templeton Fixed Income

Carlos Ortiz
Research Analyst, Franklin Templeton Fixed Income

Jamie Altmann
Research Analyst, Franklin Templeton Fixed Income
Key Takeaways
- A potentially record-breaking El Niño is a risk for emerging markets, particularly for food and energy inflation and economic activity, although impacts vary substantially by country and region.
- Emerging markets with greater reliance on agriculture and hydroelectric power are most vulnerable, while a handful of countries, such as Argentina and Paraguay, may benefit from improved rainfall and stronger agricultural exports.
- The economic impact is likely to be delayed, with inflation and growth effects emerging most strongly over the next 12–18 months, reinforcing the importance of a selective, country-specific investment approach.
Understanding El Niño
An El Niño is a weather and climate phenomenon that occurs every three to seven years and forms when trade winds weaken, meaning warm surface waters are no longer pushed westwards across the Pacific Ocean and instead remain in the central and eastern Pacific. An El Niño occurs when the three-month running average of sea surface temperatures in the central Pacific rises at least 0.5°C above normal, with readings of 1.0°–1.4°C classed as moderate, 1.5°–1.9°C as strong, and 2.0°C or above marking a very strong, or 'super,' El Niño. This relatively small change in winds and ocean temperatures can have significant global implications, contributing to higher global temperatures as well as severe localised and regional weather disruptions across the globe. Estimates of the economic costs of El Niño vary greatly but run into the hundreds of billions of dollars globally, with the African Development Bank expecting the upcoming event to cost the African continent alone up to $US20 billion in gross domestic product (GDP). Exhibit 1 highlights the typical weather patterns associated with an El Niño event. The opposite phase of the cycle, known as La Niña, occurs when trade winds are stronger than normal and generally results in different weather outcomes, although this paper will focus on El Niño.1
Exhibit 1: Typical El Niño Weather Patterns Across the Year

Sources: Ropelewski, C. F. and M. S. Halpert, 1989: Precipitation patterns associated with the high index phase of the Southern Oscillation. J. Climate, 2, 268-284. Mason and Goddard, 2001. Probabilistic precipitation anomalies associated with ENSO. Bull. Am. Meteorol. Soc. 82, 619-638. National Oceanic and Atmospheric Administration. “Understanding El Niño &Amp; ENSO.” Last modified June 10, 2026. https://www.noaa.gov/understanding-el-nino.
From Weather to Markets
There are five key takeaways we believe investors should keep in mind going forward. First, El Niño is a global phenomenon with highly localised impacts, meaning the weather and macroeconomic effects can differ materially across countries, within countries and from one event to the next. Second, a stronger El Niño increases the probability of typical impacts associated with these events, but it does not guarantee a proportionally larger weather and macroeconomic shock. Third, the macroeconomic effects often significantly lag, with inflation and growth impacts typically emerging up to 12–18 months after the weather event begins. Fourth, emerging markets are generally more exposed than developed economies, owing to their greater dependence on agriculture, hydroelectric generation and food within CPI baskets. Finally, multi-year El Niño events can have disproportionately larger macroeconomic impacts than the initial event.
What makes this El Niño particularly concerning is not only the severity of the event, but also the compounding impact the closure/partial closure of the Strait of Hormuz will likely have on agriculture and the passthrough inflationary impact. Beyond the direct effect on oil prices, the closure has materially disrupted fertiliser supply chains, raising input costs and further risks lowering crop yields, exacerbating the existing El Niño shock discussed in this paper.
Given the resulting upward pressure on local interest rates, we believe this more broadly supports a shorter-duration bias in local currency bonds. That said, the idiosyncratic nature of El Niño, and the fact that its impact can vary materially across regions, countries and even individual El Niño episodes, still reinforces the importance of a bottom-up approach to emerging markets investing. This requires focusing on country-specific details, from soil moisture and reservoir levels (South Africa appears to be starting this episode from a relatively favourable position) to the timing, location and magnitude of any monsoon shortfall in India. We are therefore paying particularly close attention to the inflationary impact across countries. This differentiated growth impulse also supports our positive view on Argentina, where the Southern Cone's broader agricultural and export benefit reinforces our constructive stance on both the credit and local bonds. Despite some similarities, Ecuador does not benefit in the same way, as its coastal exposure to El Niño typically brings flooding and disruption to shrimp and fishing output, weighing on growth and supporting our less-favourable view on the credit there. Notably, social risks will be elevated, which will likely spill over into fiscal and political risks over the coming period.
Endnote
- Sources: Cullen S. Hendrix, “El Niño Could Drag Down the Global Economy by Almost $1 Trillion or at Least $7 Trillion—and the Choice Is Ours,” RealTime Economics, Peterson Institute for International Economics, July 20, 2026, revised August 18, 2026; “Africa Facing Up to $20 Billion Economic Hit from ‘Super’ El Niño, AfDB Climate Chief Warns,” July 26, 2026, Reuters.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically.
The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries. There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact a portfolio. Investments in Hong Kong and Taiwan could be adversely affected by its political and economic relationship with China.
The allocation of assets among different strategies, asset classes and investments may not prove beneficial or produce the desired results.
Sovereign debt securities are subject to various risks in addition to those relating to debt securities and foreign securities generally, including, but not limited to, the risk that a governmental entity may be unwilling or unable to pay interest and repay principal on its sovereign debt.
