How climate change and the extreme hot weather could reshape the global economy
El Nino and other such events contribute to the kind of stagflation that central banks struggle with
AS WE all swelter in our very own heatwave here in the UK, spare a thought for what might be barrelling towards folk in equatorial regions – a super El Niño event.
After a weak start to 2026, forecasters are now putting the probability of such an event persisting through the end of 2026 somewhere between 80pc and 90pc.
In a super El Niño, sea surface temperatures in the central and eastern equatorial Pacific could run more than two degrees above normal, driving possible droughts across south-east Asia, India and Australia, while dumping excess rainfall on South America and parts of the southern US.
The investment implications – and opportunities – could be major. The backdrop to this weather event could not be more ominous. Many countries are already struggling to cope with the disruption caused by the war in Iran. As Torsten Slok, the chief economist at Apollo, a large US private equity firm, notes, commodity prices are already moving higher across the board, but for different reasons in each segment.
Middle East supply disruptions are lifting energy and fertiliser prices, while the data centre buildout, alongside electric vehicles and electrification, is driving demand for base metals such as copper and aluminium. El Niño might make the global inflationary pulse even stronger and hit global growth outside the US.
According to David Rees, the head of global economics at Schroders, the main channel for economic disruption might run through supply-side cost-push inflation, and that is precisely the kind of monetary policy that is awkward for central banks.
Rees has warned that if “past correlations were to hold, then a very strong El Niño would imply a doubling of global food prices from current levels over the next year or so”, potentially adding more than a percentage point to developed-market headline inflation within 18 months.
Rees also warns that “the longer inflation remains elevated, the greater the chance of second-round effects on wages that could see price pressures become ingrained”.
And don’t for one minute think that Europe will not be affected by extreme weather events. A paper by economists at the European Central Bank (ECB) found that the extreme summer heat of 2022 increased food prices in Europe by around 0.7 percentage points, and that a heatwave on that scale could add as much as 1.8 percentage points to food price inflation by 2060 as the climate warms.
The ECB’S working paper on heatwaves and their economic effects is worth reading in full, and the economists identify a key risk: climate events are not typical supply shocks. That is because these shocks can generate inflationary pressure without boosting economic activity – a recipe for the kind of stagflationary environment that central banks struggle with. A related ECB regional study covering more than 1,100 EU regions found that a single summer heatwave could reduce regional output by around 1pc, with the effect deepening to 1.5pc two years later.
Droughts are even more persistently damaging. Regional output in Europe can remain up to three percentage points lower for four years following a severe drought. So, what are the investment implications? Some fund managers, such as Wisdomtree, recommend increasing your portfolio’s exposure to commodities more generally.
I’m a bit cautious about this argument, as investing directly in commodities has not always been particularly rewarding, even as prices have been incredibly volatile.
Many active fund managers are hunting for specific opportunities in niches such as robusta coffee, sugar futures and fertiliser producers such as CF Industries and Nutrien. More specifically, it might be worth keeping a close eye on cost pressures for food multinationals such as Nestlé, Unilever and Barry Callebaut, which could face serious raw-material cost headwinds from cocoa, sugar and coffee.
Also, the reinsurance sector will be affected first by claims, then helped by premium repricing. And then there’s my favourite secret success story of modern thematic investing – water funds, a niche I have invested in successfully for many years. There’s a small but vibrant world of funds, mostly passive index-tracking, that focus on the water industry.
This takes in both the boring utility businesses and more exciting technology and engineering plays. In the former are the likes of Severn Trent and United Utilities, and in the latter category are Xylem and Veralto.
El Niño or otherwise, freshwater demand has been growing at more than twice the rate of global population growth for decades, while climate stress is straining aquifers and surface water systems across the US Southwest and the Mediterranean.
And a new demand driver has arrived in the form of AI: a singlemegawatt data centre can consume up to 25.5 million litres of water annually for cooling, and Goldman Sachs estimates current global data-centre water use of roughly 560 billion litres annually could double by 2030 to
1.2 trillion litres.
Global water-themed fund assets have increased substantially to the tens of billions since 2020 as investors have woken up to this theme.
The leading Uk-listed exchangetraded fund (ETF) vehicles include ishares Global Water, L&G Clean Water, Amundi MSCI Water and Global X Clean Water.
Whatever fund you end up with, my view is that you buy into meaningful diversification away from AI hardware stocks, in a globally sensitive niche that benefits from the constant expansion of demand driven by more common and increasingly extreme weather events.