"A Headwind For Policy Normalization": Morgan Stanley Adds El Niño To List Of Inflation Risks

By Seth Carpenter, Global Chief Economist at Morgan Stanley

My father has teased me that the cosmos created meteorologists in order to make economists feel better about their forecasts. This year, that joke will be particularly salient. Weather forecast models suggest there is a 90% chance of a moderate El Niño weather event and a 66% chance for a particularly strong event. El Niño is a phenomenon where typical Pacific weather patterns reverse, with some regions getting more rain (the US, Argentina, and the Andes) while others face the risk of drought (Southeast Asia, Australia, Brazil, Colombia, Africa, Central America, and the Caribbean). The last strong El Niño cycle occurred in 2015/16 and brought food price volatility and energy disruptions. Recent shocks from Covid and the Russian invasion of Ukraine have already caused volatility in these markets, so a severe El Niño event could heighten global risks, perhaps more than in the past given climate change.

Recall that the Panama Canal ran low during Covid, exacerbating backlogs in global shipping. More specifically, the Gatun Lake in Panama, which the canal uses to operate its lock system, is particularly susceptible to droughts. If water levels fall too low, the lock system is unable to sustain normal levels of activity. This year, drought has already restricted ship traffic. Capacity is currently averaging 32 ships a day, down from the typical 36-40, and weight limits and higher tolls have been imposed to control the flow. Further drought could strangle the channel, and the last few years have amply demonstrated how fragile global supply chains are.