The Oil Blockade Isn’t Spooking Markets — Yet

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1:42Today's number, 1.2 trillion. That's how many dollars the US government racked up in deficit spending in the first half of this fiscal year on track for more than$2 trillion for the full year. That is a roughly 20 % increase from the previous year. Thank God for fiscal conservatism. Money markets matter. If money is evil, then that building is hell.

2:14Welcome to Profity Markets. I'm Ed Elson. It is April 14th. Let's check in on yesterday's market vitals. The major indices climbed on hopes of a deal with Iran. Meanwhile, while oil prices rose as the US moved to blockade the Strait of Hormuz. We'll talk about that in a second. The yield on 10-year treasuries fell, and finally, Oracle shares surged nearly 13 % after the company revealed new AI tools for the utilities sector that gain led software stocks higher, with broader sentiment turning positive to start the week. Okay, what's happening? The U.S. Navy has blockaded the Strait of Hormuz. The blockade went into effect yesterday morning after peace talks in Pakistan collapsed this weekend.

3:03In a post on Truth Social, Trump threatened to, quote, eliminate any Iranian ships that come near the blockade. Oil jumped nearly 8 % on the news, climbing back above$100 per barrel. By the afternoon, Trump said Iran had reached out about negotiations and oil prices paired some gains. This latest trouble at the strait follows a hot inflation report back in the States, where the price of oil has already pushed gas prices higher. So here to discuss what this blockade means, what these latest developments in Iran mean, we are speaking with Michael Gapin, Managing Director and Chief US Economist at Morgan Stanley.

3:42Michael, we have a blockade on the blockade. and it's a little hard to understand how everyone feels about it because we do have oil prices obviously rising, but then also we have stock prices rising. I mean, investors seem to be somewhat bullish in a lot of ways coming into the week. What do you make of this blockade? What does it actually mean for investors? Well, you're right that I think investors, I don't want to use the word complacent because certainly they're not complacent, But I think they're optimistic in the sense that the interpretation of markets is that the day-to-day events here are probably still what they would call a de-escalation camp, meaning it doesn't appear like things are escalating in a way.

4:32So oil is staying around this$100 per barrel level that's certainly a lot higher than it was going into it. but the view from the market is hundred dollar oil may not be great but it's something the u.s economy can withstand and the global economy can withstand as well so it's it's inflation's rising yes that will crimp purchasing power we can we can talk about that but it's does not appear that oil is at a level that would destroy demand right because a little bit of oil I mean, I should say it's been more than a little, but a large increase in oil, it initially shows up inflation, but if it rises too much, then what it starts to do is weaken activity.

5:16And I think the market is telling you, we're in that first stage. We're in that first part. It's likely an inflation story. It may dampen demand, but the global economy should remain in an expansion in 2026. And that's why I think stocks have rebounded. What do you make of the inflation report that we saw as well for March came in at 3.3%, two-year high, gasoline up over 20 % in a single month. I mean, that inflation report was pretty bad, but of course it is measuring, I mean, the immediate effects of the war in Iran. I mean, as the US economist over at Morgan Stanley, like, what are you supposed to do with that data?

5:59Is that meaningful in your long-term projections of how things are going to go. It's certainly meaningful for where we think headline inflation is going, right? So we typically split out headline and core. Core is X energy and X food, because these are commodities determined in global markets. And core kind of gives us a view of where underlying inflation trends may be going. And the data history in the U.S., I mean, this goes back 30 to 40 years now, where shocks to oil tend to push headline inflation higher in the U.S., but it often has very limited second-round effects on core. That's important from the economist's point of view because you're saying, okay, we get the direct effect from energy, we can't avoid that.

6:49It goes right into gasoline prices very quickly in the U.S. But the good news is history says we don't get second round effects where other prices rise because gasoline prices are higher or oil prices are higher. So we've raised our forecast for headline inflation. We actually think headline inflation will peak around 3.7 % on a year-on-year basis. So there's still probably a little more to come in that regard. But we really haven't changed our outlook on core inflation. We think core inflation can actually move a little lower as we get into the second half of the year. That will be dependent, though, I think primarily on whether the tariff pass-through to goods prices ends.

7:32We think it will by the middle of the year. But that's how we're looking at it. It's a boost to headline inflation, but it may not change the underlying dynamics of inflation, and inflation could be lower by the end of the year. walk me through that thesis then because my understanding is i mean yes we see the obviously immediate impacts of oil prices on gasoline but we also know that what's what's happening if there's if the strait of hormuz is blockaded further um then i mean fertilizer prices will go up you need fertilizer to grow food which would mean food prices would go up in addition you know you need gasoline to transport things around the country, to move stuff from countries to other countries.

8:18I mean, my understanding is that pretty much the whole economy is dependent on oil in one way or another. So how would it not pass through to core inflation, to things like food, groceries, consumer goods, etc.? Well, two things. One is higher oil prices tend to weaken activity, right so gasoline prices go up you and i pay more for prices at the pump we can't spend it elsewhere so demand in the economy actually slows and it's that softening in demand and that softening in activity which means other prices don't tend to go up now this is just what history suggests is the guide it may not be the case this time around inflation the u.s has been above its 2 % target for about five years.

9:10And you make good points about, let's say, the downstreaming of oil into other distillates and products. And like, for example, food costs do involve a lot of transportation. So it's conceivable maybe we do get some second round effects this time. So history says we won't, but we can't be too blasé about it. And we may get it. The other point I'd like to follow up on that. It's a good point you make is right now we're still largely talking about this as the effect of higher oil prices. What you're getting at with the closure, the potential long-term closure of the straight is, well, at some point this may turn into a quantity story.

9:54Right now I might be able to get as much oil as I need at a higher price. What happens if it's not available at any price. Then you could start to see things through the lens of supply chain disruptions like we had during COVID. Where that's going to show up first is in Asia, because I think, as you know, about 85 % of the oil that comes out of the Strait of Hormuz, its destination is Asia. So if some economies are going to experience outright shortages first, it will be there uh and and then you're talking about i can't get the oil or as you say the fertilizer uh or the distillate that that i need therefore activity has to to stop so those are the risks we could get second round effects on inflation because we've been above target for for so long or this this conflict could go on long enough where it actually it changes from price effects to quantity effects.

10:52Then, you're right, we could see a much more persistent inflation story. Right. It is really interesting, just and kind of depressing almost, that when you look through history, basically what you're describing is that when oil prices rise, the reason that everything else doesn't rise is because people are so strapped for cash that you literally can't test them that much further. Either way, the situation is you're testing the American consumer literally to their limit. And if you hit that limit, then there is a world in which, you know, companies will basically say, OK, well, we can't raise our prices further because they're just not going to pay for this.

11:31It does get into sort of murky territory, I think, when we think about things like food, where it's like, well, you got to pay for food. But I mean, it's just striking that we are getting to that point. Just from an investment perspective, I mean, the way this story has changed is getting almost comical. Like, we start with, you know, we're only going to be in Iran for four or five weeks. Then we say, actually, we're going to increase that and we're going to create a deadline. And then we get to the deadline and we say, we're going to escalate this. And then we say, actually, no, we're not escalating it.

12:06Now we have a deal. And then we say, actually, wait, no, the deal didn't really work because now more bombs are being dropped. And so now they're going to blockade the thing. So we don't have a deal. Now we're going to blockade in response. I mean, in a funny way, nothing is really happening here. And yet every time something happens, the market is reacting and saying, OK, something's changed. Now we have a blockade. Now we don't have a blockade. Now oil is going to pass through fine. And to me, I'm sort of like, shouldn't we just not even be reacting at all? What is the correct response to what we're seeing?

12:44You laid it out very well. I would argue that markets are reacting a little less to the headlines now than they were two to three to four weeks ago. So as you said in your introduction, oil was up around 8%, 9%, 10 % today in response to the implementation of the blockade, but U.S. equity markets did okay today. So I do think the market is discounting a little bit the headline noise, looking through some of the day-to-day volatility in a way that it did not do it a few weeks ago. So I agree with you that it can be very disconcerting to hear headlines one way one day and the other way the next day.

13:24But I think the market's actually starting to filter that out better and volatility has come down. I think a second factor behind that is markets had to de-risk for the first two to three to four weeks of this, right? Most investors were positioned for rates to fall, at least at the front end of yield curves, all throughout most of the world, not all the world, but much of the world. And what this oil price shock did, of course, was push yields higher. So markets needed to rebalance and de-risk and get out of positions and kind of get flat or neutral, as we would call it. That process leads to a lot of initial volatility.

14:06But now that positions have been squared, to use the terminology of the industry, and risk is a little more neutral, now markets can afford to look through some of this headline noise. Yeah. I mean, we've seen how investors are reacting. As an economist, it's a slightly different job because you're not necessarily trying to make a bet on what's going to happen. and you're just trying to understand what are the possible potential scenarios, what are the possible futures. I guess, as an economist, I mean, when you put your economist hat on, how seriously have you taken these developments in terms of their potential to, I guess, adjust the trajectory of the US economy?

14:54Like, when you see the headlines and you see, okay, now he's blockaded the blockade, Do you look at that and then say, okay, well, this is going to change the economy in this way, or this isn't going to change things? I mean, how is an economist supposed to digest what's happening here? So the way that we've approached it is to kind of think of the world through three lenses, three possible paths here. One is kind of the everything goes back to normal and we return to February 27th. We think that's very unlikely. We think there has been a structural regime shift in the balance of power in the Middle East and the way oil flows in and out of the straits.

15:40So we're not here thinking, hey, if we just get over this or that, things are going to go back to where they were six to eight weeks ago. So that leaves us kind of two possible outcomes. Obviously, there's more than two, but I'm just in terms of trying to think about how things may go. And one is what I'll call the oil is high, but not too high. And then the second one is oil moves so high as to create recessionary kind of outcomes. So there's a non-linearity here where above a certain price, oil becomes really problematic for the U.S. expansion and the global expansion. Below that level, it's kind of what I was saying before.

16:21It's about a spike in headline inflation. It suppresses demand a little bit in the U.S., but the U.S. economy continues to go and the expansion continues. After all, we had about$120 per barrel oil at the beginning of the Russia-Ukraine. conflict that was a slightly different u.s economy at that point in time a lot of fiscal stimulus in the economy a lot of jobs being added but you know these this price level of oil is not not unusual so we have passed it through the lens of essentially saying well the average consumer about two and a half percent of their spending goes to to gasoline right lower and middle income households, it's more like four to five percent.

17:04It's about double the average. And so what it's really doing is that shock, that hit to real disposable income and real purchasing power is basically offsetting the fiscal stimulus that we assume from the One Big Beautiful Bill Act. So in some of our prior conversations, you know, before the Iran conflict started, we were talking about how optimistic the outlook was for the u.s this year right we've turned we've trimmed the sales on that from growth rates that could be above two and a half percent closer to three percent maybe and thinking well this is just going to offset that fiscal stimulus maybe it's another year of growth around around two percent but you're getting inflation moving higher maybe we get the fed cuts that we were expecting maybe we don't maybe the fed stays on the sideline so right now we're saying it's a headwind but we need to be watchful as as we were saying that maybe it becomes a quantity story maybe it does re-escalate maybe oil moves to 125 to 150 dollars a barrel and then i think equity markets would look much weaker sentiment would be worse and in addition to weaker spending maybe what you get then is negative wealth effects and the private sector that says, well, let's delay that capital spending plan.

18:24Let's delay those hiring plans. And then the economy can slow down much more abruptly. All right. Michael Gapin, Managing Director and Chief U.S. Economist at Morgan Stanley. Michael, always appreciate your time. Thank you. Thank you. After the break, we look at Anthropik's cybersecurity threat. And if you're enjoying the show, please follow our new Prof G Markets YouTube channel. The link is in the description.

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21:33We're back with Prof G Markets. Anthropic announced its most powerful model yet last week and decided the world isn't ready for it. The model, called Claude Mythos, found thousands of previously undetected software bugs and identified security vulnerabilities in every major operating system and web browser. Instead of a public launch, Anthropic is limiting access to a group of the world's biggest tech companies, including the company's major competitors. The consortium known as Project Glasswing will use mythos to find and patch vulnerabilities before bad actors do. So, how powerful is this model really?

22:10And what does it mean for cybersecurity in the future? Joining us to discuss this, we're speaking with Teresa Payton, CEO of Fortalist Solutions and former White House Chief Information Officer. Teresa, I mean, this model, regardless of what we even know about it, has just totally shaken everyone's confidence. And it was very scary that they basically got together and said, we're not even going to release the product because it's that powerful. What do we know about this model and what are your takeaways from the announcement of Claude Mythos? Sure, absolutely. You know, thanks for having me. And this is a very important topic for a couple of reasons.

22:50One, I know there is sort of a camp that says, well, maybe this is a marketing ploy or maybe they're overplaying their hand on this and it's not as bad as we think. And for all intents and purposes, they're allowed to say that for now until we have a third party point of view, because this is self-reported by Anthropic. However, Anthropic at their ethos talks about having an ethical constitution, and they've brought in a lot of experts from the outside to talk about safety and ethics and security and reliability. So let's assume the self-reporting is accurate for right now until we know more. If it is accurate, that means that Mythos as a frontier AI is actually the smartest AI on the planet right now.

23:41And if it is true based on their self-reports, it's going to be the best and the worst nightmare for cybersecurity teams everywhere. I'm going to quote somebody on my team who said, I won't say the name, a bomb just went off in the cybersecurity industry, and we all need to read everything we can about it to understand how it can help us and how it can be used against us. What do you make of how the markets have been reacting because, I mean, if we look at what happened last week, Mythos is announced and it did look like a bomb went off. I mean, some of the biggest names absolutely plummeting.

24:17Then we come into the beginning of the week and people seem a little bit less concerned. Some of these big names, CrowdStrike was up, Palo Alto Networks went up, Cloudflare went up. Like a lot of the big cybersecurity names are actually rallying now. What changed in the minds of investors, do you you think? Oh, well, I mean, they did have a weekend to think about things. I mean, it's interesting. I mean, there is strategic positioning around what day of the week you deliver bad news. And so people had the weekend maybe to think about it, but also to say, you know what, let's learn more. So there's this consortium coming together with Anthropic, and we're going to hear more.

24:58But again, if the self-reporting is true, that means that Mythos, in a limited release, found thousands of very serious bugs, including zero days. They said some of them were hidden almost over two decades. And if that is the case, that means that every cybersecurity product that has been installed did not find these. And so we have to ask the question, what does that mean for today's cybersecurity products? And are they going to have to completely reimagine the design of these products with a tool like Mythos? Now, also, what if somebody else has built a tool like Mythos, but they don't have the ethical kind of foundational elements that Anthropic has committed themselves to?

25:49That should also be a huge concern right now because there could be a hidden mythos that none of us is aware of that is ready to launch. What are you supposed to do then as someone who works in cybersecurity? Like, what are you supposed to do with this information? I mean, clearly it's a bad idea to just write it off and say, oh no, it's all just marketing. It's not real. It's not serious. But then on the other hand, I mean, how do you accept your fate? Like, are you just accepting fate if it's just this is just infinitely more powerful than all of the solutions that we've had in the past? And this is going to completely destroy the industry as we know it, or at least completely disrupt the industry as we know it.

26:31Like, what do you do if you're working in cybersecurity and you see this? Should you really be, I mean, how do you process it? How do you even change your behaviors moving forward? I think this opens up a new door. You know, the way I like to think about this, you know, I used to live in Hawaii. And so when the tsunami bell goes off, you don't say, oh, gosh, this is it. This is when we're all gone. You go to higher ground. Right. And so and you know the plan and you get the playbook out and you hear the bell, you hear the warning, you find out how much time you have and you execute against that plan.

27:03And so this should be our tsunami bell warning of whatever you were planning on doing. You need to operate at machine speed and not at bureaucratic speed. So a couple of things, because I don't want people to not feel empowered and engaged on what to do here. So if you're an executive listening to our conversation right now, a couple of things you need to be doing. You need to be asking your vendors and your CISO right now, how are we systematically testing our critical software, our open source dependencies, our cloud infrastructure against AI augmented vulnerability discovery? because Mythos will eventually be commercially available, but somebody else may make it available and it won't be in the good guy's hands, it'll be in the bad guy's hands.

27:50Ask whether or not, because of the vendor relationships you already have, do you have access to get intel for what they're learning as they continue to run the tool? And then also be asking your board and your risk committees if they are getting regular quantified updates on the exposure that the company has due to sort of this dual-use AI risk of frontier models being used against you instead of on your behalf. I would say for the security teams, a lot of the things you already had on your roadmap that you just haven't had a chance to get to because the enterprise you work for hasn't prioritized it or put money against it, the door's now open for you to go back in and have that conversation to say, we have to operate at machine speed because that's gonna be what's coming at us.