It was undoubtedly an explosive week for the Invesco QQQ ETF (NASDAQ: QQQ), which jumped 7%, echoing the March rally. Moves of this size certainly excite a lot of people. But let’s be real, nothing has changed this week for QQQ’s outlook, just that it has finally recovered after falling for seven straight weeks.
The only good thing for the QQQ was that the Fed minutes revealed nothing new. This helped drive down implied volatility levels across the market, leading to a frenzied buying spree. But based on the weight of evidence, the QQQ and NASDAQ rally would appear to be nothing more than a mechanical bounce due to the implied unwinding of volatility.
Rates appeared to have no opinion on the FOMC minutes and remained roughly unchanged after the release. Eurodollar futures saw no material change in the path of future rate hikes from their level 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 minutes. So if there was a dovish surprise in the Fed minutes, the interest rate market certainly didn’t pick up on this change in tone.
This suggests that the stock market and QQQ rally was a de-risking event that led to lower implied volatility in a 3-day long weekend. This means that there is a good chance that next Tuesday hedges will start to be placed and implied volatility will start to rise again.
Is it possible that the QQQ and stock market buying frenzy will continue for a few more days or even weeks? Sure. But that depends on how markets view volatility next week, after the long holiday weekend. Suppose investors are beginning to feel satisfied with the path of monetary policy. In this case, demand for protection could fall further, pushing implied volatility lower, which may help boost QQQs further.
The NASDAQ 100 volatility index is the VXN, which is equivalent to the VIX. It’s just that the VIX measures implied volatility in the S&P 500. The two track each other closely, so I’ll be using the VIX in the future as it’s more widely known and followed as a measure of implied volatility.
The VIX, since early May, has bottomed out around level 25-26. This makes this region 25-26 critical; If the VIX continues to push lower in several macro data points this week, such as the ISM manufacturing PMI and the BLS jobs report, there is a very good chance that the market will rally further. However, if the VIX starts pushing above 30, then all of the gains from the past week will disappear.
There is a good chance that the VIX will rise again this week. Starting in December, the jobs report became much more market-critical, as noted by the VIX. Employment reports for December, March and May showed the VIX to be at the upper end of its trading range. Meanwhile, January, February and April reports found the VIX lower.
The fluctuations in the VIX could be due to the fact that the FOMC meeting in January had very low expectations for any policy changes, while there was no FOMC meeting in February. Moreover, like the other months, the April employment report was of little importance since there was no FOMC meeting. June will feature an FOMC meeting, which likely means that this jobs report will have significant significance, which could be enough for traders to look to put some hedges back in place in this week’s report.
Not only do these factors present challenges for a sustained long-term recovery, but we need to remember what the Fed wants, which is for inflation to come down sharply. The Fed wants financial conditions to tighten, and if it sees financial conditions easing too much, the Fed is likely to step up its rhetoric and begin to bring the market back to where it wants. This would mean that financial conditions are heading towards neutral and potentially restrictive over time depending on the reading of the Fed’s minutes. This is what poses the biggest risk to the QQQ, and it will make fighting the Fed a difficult task.