Weekly Buzz: El Niño's heating up, but your portfolio doesn't have to

Oil prices have tumbled following a US-Iran truce, and that’s taken some heat off inflation. Forecasters are now putting El Niño back on the weather map, however, and this climate disruptor could raise the temperature for markets. A strong episode of this Pacific-warming pattern could hit crop yields and weigh on growth.

What’s going on here?

El Niño ("the little boy" in Spanish) and La Niña ("the little girl") are opposite phases of a natural climate pattern across the Pacific Ocean. That cycle swings back and forth every two to seven years on average, with El Niño the warm phase, La Niña the cool phase, and a neutral phase in between.

El Niño tends to hit hardest where farming makes up a large share of the economy. Weaker monsoons could hurt India's rice, cotton, and soybean output, while drought and bushfires could hinder wheat production in Australia. Bloomberg Economics modelling from 2023 found that a strong cycle could shave about a third of a percentage point off annual growth in Australia, Peru, and the Philippines, with India and Argentina closer to half a point.

The impact tends to concentrate in commodities and food prices. The European Central Bank notes an El Niño lifts global non-energy commodity prices by around 5%, an effect that lasts six to sixteen months. It helps, though, that this is a risk you can see coming. Forecasts arrive months ahead, which gives producers time to adapt and markets time to price it in.

What’s the takeaway?

El Niño has a genuine impact, but likely a narrow one. It tends to bear down on particular crops and regions, rather than the market as a whole. For long-term investors, that's the kind of risk a globally diversified portfolio is built to weather. When one region feels the heat, others stay cool, and any single shock fades into the bigger picture.

(For a portfolio that’s built with global diversification in mind, check out General Investing.)

In Other News: Market volatility has cooled off for now

Markets got calmer last month, according to options trades. Implied volatility declined across the board as investors moved past a major worry: the US-Iran conflict. Implied volatility is the amount of movement, up or down, investors are pricing in for an asset, based on options prices. When implied volatility falls, investors are expecting a less bumpy ride ahead.

Unsurprisingly, the biggest move is with oil. After negotiations to end hostilities, Brent crude oil prices have fallen to roughly $73 a barrel. Oil-market risk sentiment has also normalised: USO, an exchange-traded fund that tracks US oil prices, saw its one-month implied volatility drop from 50.9% to 22.5% over the week commencing 15 June.

The VIXTLT Index, which tracks expected volatility in US Treasuries, also dropped to a first-percentile low. While the Federal Reserve’s tone was hawkish – nine of 18 committee members now expect a year-end rate hike – the market appears to be looking through it, with the probability of a second hike remaining low at about 30%.

Stocks also took a breather. The Cboe Volatility Index, or the VIX, declined to roughly 17 from a peak of 22 early in June. The VIX is a forward-looking measure of expected market volatility based on a basket of S&P 500 options, so it gives a read on how much movement investors are pricing in for the broader US stock market.

These articles were written in collaboration with Finimize.