Tin Hat? Check. Safety belt? Check. Parachutes/life vests? Double-check. Well-stocked New Zealand farm? Check. Tank? Check. Basket of long-dated puts on the Kospi, Nikkei, and low-vol ETFs to hedge the portfolio? Check. Now we can finally we can get some rest as the third quarter begins.

I don’t know what it is…

The current macroeconomic environment presents so many perplexing features that it’s hard to say which is the most puzzling of all.

For instance, there is the fact that US volatility has only been lower 3% of the time since the 1930s. Or the fact that – against my expectations and continued view – inflation in the US and the Eurozone seems to have flatlined at best, and could be retrenching, potentially taking us back into a yield compression world. Or there is the fact that every time the US Federal Reserve raises interest rates, the bond market acts like everything’s done and dusted, and future hike expectations get lowered.

We also have the fact that oil looks dangerously close to breaking below $40/barrel as we approach the end of the second quarter, and a contracted close below $40/b would unleash one of the key risks I mentioned in my Q2 outlook: the deflationary genie. Finally, we have the fact that the most heavily discounted potential geopolitical crisis – a conflict between the US and North Korea with potential collateral damage and nuclear weaponry at stake – seems to be escalating, and no one seems to care.

In any case, the third quarter could shape up to be an inflection point for the year. I am thinking protection – as in keeping an umbrella close by when you’re inside the house. Because remember: to win you have to stay in the game.

Consensus view and positioning?

The consensus is bearish on yields and US rates moving further up, as the markets don’t believe the Fed’s projections. Speculative longs in US Treasuries are now close to record levels. Some say that inflation is dead and it just does not know it, and bond bears are now extinct. At the same time, investors are so long FANG (Facebook, Amazon, Netflix, and Alphabet) stock that it’s falling out of their pockets.

Everyone seems to agree the US equity market is overvalued. The recovery is long in the tooth, they say, weakest at hand, yadda yadda yadda. They say the US dollar’s back has been broken, the bull will never buck again. They say the dead money that Europe represented for a decade has risen like a phoenix from the ashes, and that French president Emmanuel Macron is the best thing since sliced bread and Jack Daniels.

They say Brexit will be disastrous for the UK, so you should be short sterling and UK assets. They say a US-North Korea conflict could never happen; China would not allow it, and/or the cost to Seoul would be too high. They say the Trump reflation trade is dead, and absolutely nothing is going to come from this administration – no deregulation, no tax reform, no infrastructure or healthcare bill.

They say that credit loan growth is dead so we can forget about any economic growth from that side of the balance sheet…

With all due respect, I am more likely to take the opposite side of these trades. I will be the first to admit that inflation needs to pick up, or we could be back in the yield compression trade, though I think we are six to 18 months early on that view. Talk to anyone you know in the US – friend, family, peer – and ask whether it’s getting cheaper or more expensive to live in America. That’s what I thought: inflation is not dead, folks.

The risk is to the upside for CPI surprises, and yields to climb.

Perhaps I am in a room of one, but until I see another three months of CPI data, my thesis of structural short duration and yields higher still stands – and again, I think it is better played out in the Eurozone than in the US.

Global macro hedge funds performance

In my view, and for those who follow our weekly Macro Monday Cross Asset product, there have really only been two opportunities to make some serious money in global macro, year-to-date. That was the run-up to the March Fed hike, when gold and US bonds offered very compelling risk/reward shorting opportunities as the market was late in adjusting to a Fed determined to move.

The second opportunity was one week before the first round of the French elections when bonds yields got way too tight. Everything else this year has been very tactical.

Some of the biggest global macro funds are struggling this year and are down by as much as 10%, while a few outliers are up 10-15%… this just goes to show that there are always opportunities, no matter what. Overall I get the feeling if you are flat to slightly up year-to-date, then you are performing relatively well in the global macro/multi-strat space.

Judging by the track record of our two Macro Monday books (Tactical and Strategic), it’s interesting to see the outperformance (ytd) at least of the Tactical Book (shorter-term, bigger positioning, much more active) versus the Strategic Book (longer-term, smaller positioning, wider targets, less active).

This basically illustrates the low volatility and challenging environment we are in, where apart from equities many assets have been rangebound.

Macro Monday’s Global Strategic Book: Plus 2.49% as of June 16, 2017, to $10,248,644

Macro Monday’s Global Tactical Book: Plus 6.29% as of June 16, 2017, to $10,628,907

Three things come into mind for the third quarter and beyond: two equity option baskets and a futures position.

January 2019 Fed funds futures [Saxo ticker ZQF9] at around 98.50 are pricing in only one more rate hike by the end of December 2018. That’s seems to be the epitome of wrong, given that Fed chief Janet Yellen said after the June 14 hike that things are still on track for one more rate rise in 2017 and three increases in 2018.

Even if the Fed delivers only half of that, shorting those futures should still prove to be an asymmetrical trade. So: short from around these 98.50 levels, with a stop at 98.65 and targeting 98.25 and 98.10. Note that these are small moves in percentage terms, so your position sizing must be pristine as these are Epic Earl positions (not Tiny Tim) given the volatility.

Given the inflection point of inflation in Q3 and the determining factor in deciding whether this is a Fed that’s following through or reversing, US banks are most likely destined for a binary move this quarter. I love the low volatility, as it means option premium is cheap. I want to buy a lot of premium; I want to build a basket of at-the-money straddles (long calls and long puts at the same strike and maturity) on US banks that will have a maturity of 20 Oct, getting us over the Fed’s September 20 meeting as well as: five US CPI Prints, four US nonfarm payroll numbers, two quarterly earnings dates, the Fed’s July 26 meeting, and Q2 US GDP.

I’d keep it vanilla and just line up the usual suspects: Citi ($63.91), JPM ($87.52), BoA ($23.49), WFC ($53.46), GS ($225.10), and MS ($45.50). If inflation surprises to the upside, financials should fly as the Fed should be on track. If inflation continues to fall apart, then we could get a back-tracking Fed, which would crush financials. The risk to this view is if inflation is neither here nor there, leading to the Fed being neither here nor there and us staying rangebound in Q3. From my side of things, I think something has to give… one way or another.

For the second basket we are talking about the FANGs and the hot semiconductor space, collectively known as the engine of this US equity bull market. So this is a basket of long-dated six-12 month (potentially even two-year) at-the-money long puts, consisting of Facebook ($152.25), Amazon ($992.59), Netflix ($152.05), Google/Alphabet ($950.63), and I would throw in SNAP ($17.31) as well as the semiconductor plays SMH ($84.57) and SOX ($1,074).

Note that prices are as of the close of June 20, 2017. We are close to dot-com era highs, but back then revenues were growing 20-30% year-on-year, while this time around revenue has flatlined, and it’s a bootstrapping game.

Call me paranoid, but going back to the risk of a conflict between the US and North Korea and the challenges that president Trump faces domestically, one must wonder whether it would be advantageous at some point for him to start a ruckus abroad. After all, it’s really only the airstrikes in Syria that have brought him any concerted praise.

Let’s just throw in one more idea so that I can sleep even more soundly over the second half of the year: long-dated six-18-month ATM puts on South Korea’s Kospi index (2,369 points) – EWY ($66.88) is the ETF – and Japan’s Nikkei (20,230 points).