La Niña to Put Another Dent in Emerging-Market Bond Returns

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(Bloomberg) — Emerging-market bonds, which have been falling out of favor this year, are set to face another threat in coming months: the La Niña weather phenomenon that’s set to drive up inflation.

Climbing food prices are likely to weigh on Latin American local-currency bonds that are already underperforming their global peers, according to Columbia Threadneedle Investments. Assets in countries such as Brazil, Argentina and Central America are especially at risk from unpredictable weather events, TCW Group Inc. says.

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There’s a 65% chance La Niña will form in the next three months and persist into 2025, according to the National Oceanic Atmospheric Administration. La Niña refers to periods of cooler-than-normal sea surface temperatures in the mid Pacific Ocean that can cause droughts in Latin America, hitting crops and driving up food costs. It can also lead to more hurricanes in the Gulf of Mexico, hurting oil production.

Weather disruptions pose an inflationary factor “that might slow easing cycles by central banks in places like Latin America,” said Adrian Hilton, head of global rates and emerging market debt at Columbia Threadneedle in London. Colombia’s central bank, for example, “can add possible climatic impacts on food prices to the list of concerns,” he said.

Emerging markets have been whipsawed by a range of extreme weather in recent years that has been attributed to rising global temperatures. Southern Brazil saw catastrophic flooding in May, while parched conditions slashed the number of ships that could use the Panama Canal in June. In Africa, Zambia’s worst drought in four decades helped convince the central bank to raise interest rates, while low rainfall in India has pushed up food costs across Asia.

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Those events have added further fuel to global inflation that’s sapping returns from developing-nation debt. Emerging-market local-currency bonds have dropped 0.7% this year, underperforming Treasuries that have lost 0.3%, according to indexes compiled by Bloomberg.

The anticipated La Niña pattern may have an especially pronounced effect this time around as it’s set to occur three months after the reverse El Niño ended, just the third occasion that’s happened since 1950, according to Swiss Re Group.

“The severe weather events brought by El Niño in 2023 and 2024 and potentially also by La Niña in the summer will likely accentuate already-high agriculture and property protection gaps across the region,” economists Fernando Casanova Aizpun and Caroline De Souza Rodrigues Cabral wrote in a research note in May. 

“A swift transition to La Niña could prolong a three-year period of high inflation as food and energy prices become subject to a supply shock,” they wrote.

TCW is watching Argentina closely as drought threatens crops, pressures the peso and weighs on the nation’s foreign-exchange reserves just as the government is seeking to stabilize the economy.

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The money manager has also turned more “cautious” than usual in the Caribbean and Central America after Hurricane Beryl, said Mauro Roca, managing director for emerging markets and sovereign analyst in Los Angeles. 

“It’s going to be a very active hurricane season,” he said. “It’s unusual to have a hurricane five at this time of the year. That probably is a warning about what lies ahead for the rest of the hurricane season.”

What Bloomberg Strategists Say …

El Niño is over, now watch out for La Niña. It tends to bring cold, wet weather to the US and Canada, dry weather in South America and rain in Australia and southeast Asia. It can often also mean a hurricane season that is bad news for Gulf Coast oil refiners, homeowners and insurers in Florida as well as global reinsurers and investors in Catastrophe bonds.

— Sebastian Boyd, Markets Live Strategist

The full impact of the approaching La Niña on financial markets will probably only be felt in the first half of next year, given the phenomena has a lagged impact on the real economy, Roca said.

“It’s a bit early to position” the broader portfolio so the fund is “being cautious in the near term,” he said.

What to Watch:

• Chinese economic activity readings including GDP, retail sales and industrial output are due this week as President Xi Jinping convenes senior party officials for a closed-door conclave known as the Third Plenum. The event may result in additional efforts to shore up the economy
• Trade data are due from India, Indonesia, Malaysia, Argentina and Colombia
• Rate decisions are due in South Africa and Indonesia, with investors awaiting any guidance about policy easing this year
• There’s also inflation from Poland, while Malaysia reports GDP

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