It has undoubtedly been an explosive week for the Invesco QQQ ETF (Nasdaq: QQQ), which jumped 7%, echoing the March rally. Movements of this magnitude get a lot of people excited. But let’s face the facts, nothing has changed this week QQQ look, only that it finally rose after falling for seven consecutive weeks.
The only good thing about QQQ is that the Fed minutes did not reveal anything new. This helped push implied volatility levels lower throughout the market, which led to a frantic buying spree. But from the weight of the evidence, it appears that the rise of QQQ and Nasdaq is nothing more than a mechanical bounce due to the unwinding of implied volatility.
Prices did not appear to have any say in the FOMC minutes and instead remained largely unchanged after the release. Eurodollar futures saw no fundamental change in the path of future rate hikes from where they were on May 24, the day before the Fed minutes, and their close on Friday, May 27.
There was also no noticeable change in the Treasury yield curve after the release of the Fed meeting minutes either. So, if there is a cautious surprise during the Fed minutes, the interest rate market certainly did not catch this change of tone.
It leaves one to conclude that the stock market rally and the first quarter QQ was a risk-limiting event that triggered a bearish implied volatility move into a 3-day long weekend. This means that there is a good chance that Tuesday will come, when the hedging position will kick in, and the implied volatility will start to rise again.
Could the frenzy of buying in QQQ and the stock market continue for a few more days or even weeks? surely. But it depends on how the markets view the volatility next week, after the long weekend. Suppose investors are beginning to feel satisfied with the course of monetary policy. In this case, the demand for protection could drop further, driving down implied volatility, which could help boost QQQs further.
The NASDAQ 100 volatility index is VXN, which is equivalent to VIX. It’s only about VIX metrics that have included volatility in the S&P 500. The two follow each other closely, so I’ll use VIX going forward since it’s widely known and followed as a measure of implied volatility.
VIX, since the beginning of May, has found itself at a bottom around the 25 to 26 level. It makes 25 to 26 a critical area; If the VIX continues lower heading towards several macro data points this week, such as the ISM manufacturing PMI and the BLS jobs report, there is a very good chance the market will rally further. However, if VIX starts to rise above 30, all the gains from last week will disappear.
There is a good chance VIX will rise again this week. As of December, the business report has become more relevant to the market, as noted by VIX. The December, March and May jobs reports showed that the VIX was at the upper end of its trading range. Meanwhile, January, February and April reports find VIX lower.
The volatility in VIX may be because the FOMC meeting in January had very low expectations of any policy shift, while there was no FOMC meeting in February. In addition, like other months, the jobs report for April had little significance because there was no meeting of the Federal Open Market Committee. June will see the FOMC meeting, which likely means that there will be significant significance to this jobs report, which may be enough for traders to consider putting the hedge back in place in this week’s report.
Not only do these factors present challenges for a sustainable long-term rally, but we must remember what the Fed wants, which is for inflation to drop sharply. The Fed wants to tighten financial conditions, and if it sees that financial conditions are easing too much, the Fed is likely to step up from its rhetoric and start putting the market back where it wants. This could mean that financial conditions are moving towards neutral and possibly restrictive over time depending on how the Fed minutes are read. This is what poses the greatest danger to QQQ, and will make fighting the Fed a difficult task.