This time is different: El Niño 2026 more likely to raise sovereign bond yields
Inflationary pressures and debt burdens could result in widening credit spreads, new research shows
The World Meteorological Organization (WMO) estimates that El Niño – a climate pattern linked with unusually high ocean surface temperatures in the Pacific Ocean – will intensify and persist until February 2027. El Niño is known to exacerbate extreme weather risk.
New research from the Anthropocene Fixed Income Institute (AFII) suggests sovereign bond markets could demand higher yields from countries less prepared to absorb the shock. AFII’s analysis, which covers 184 countries, shows that sovereign credit risk spreads could widen and price in an El Niño premium.
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This time is different
Dubbed the ‘master weather maker’, El Niño is associated with increased extreme weather risk and typically occurs every two to seven years. The 2026 episode carries unique characteristics. For one, it has formed faster than previous ones with higher intensity. The UK’s Met Office has warned it could be ‘the largest El Niño in living history’, citing unusually high sea-surface temperature increases. Never before in the WMO’s 76-year history has the organisation unequivocally predicted a ‘near 100%’ probability
of El Niño’s persistence.
“El Niño has been well covered in the literature from a commodity markets angle, because commodity prices are where most of the impacts are felt”, says Kamesh Korangi, AFII’s head of portfolio strategy. Korangi and his colleagues felt a credit market perspective was missing. In El Niño 2026, they found a global, systemically significant event to fill that gap.
Macro channels
Extreme weather tends to affect sovereign credit spreads through indirect channels. The most notable of these is inflation. AFII’s report examines inflationary outcomes linked with historical El Niño episodes. In 1997, for instance, 20% of the countries it tracked experienced inflation above expected baselines.
Sovereign debt burdens are another. Fiscal expenses tend to rise in response to extreme weather events, leading to higher deficits. The two often interact to produce vulnerabilities that bond markets respond to. “Higher inflation doesn’t necessarily need to translate into higher sovereign yields. But if higher inflation is going to worsen your outstanding public debt, then yields will rise”, Korangi says.
Rose Choy, APAC research director at AFII, points out that every El Niño since the 1990s has been concurrent with another global financial shock. AFII’s methodology identified a pattern, she says.
“We find a consistent pattern: climate-linked commodity exporters see food prices rise first and fastest. This time, they start with a much higher debt burden”, Choy explains.
At risk
When AFII compared sovereign El Niño risk exposure with five-year CDS spreads, the researchers found three countries more vulnerable than most – Indonesia, Brazil and Colombia. In each case, debt burdens are higher than they were in previous El Niño episodes. “Investors will be looking at where El Niño exposure meets a holdable stock of debt: Indonesia, Brazil and Colombia. Countries that have pre-arranged financing, like Colombia and Peru, may be in a better position to absorb the shock”, explains Korangi.
Indonesia, the sovereign most exposed to El Niño according to AFII’s analysis, has a public debt burden of roughly $547bn.
Yields might not rise across the board. Some, Korangi reckons, could be spared. “Bond markets tend to reward a clear government plan with lower volatility and cheaper borrowing”, he says.
