It was certainly a blowout week for the Invesco QQQ ETF (NASDAQ:QQQ), which jumped 7%, echoing the rally in March. Movements of this size certainly excite many people. But let’s face it, nothing changed this week for QQQ’s outlook, only it finally recovered after falling for seven straight weeks.
The only good thing for QQQ was that the Fed minutes did not reveal anything new. That helped reduce implied volatility levels across the market, sparking a frenzy of buying. But by the weight of the evidence, the QQQ and NASDAQ rally would appear to be nothing more than a mechanical bounce due to implied volatility unraveling.
Rates did not appear to have any say in the FOMC minutes and instead were largely unchanged after the release. Eurodollar futures saw no material 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 were also no notable changes in the Treasury yield curve following the release of the Fed minutes. So if there was a dovish surprise within the Fed minutes, the interest rate market certainly didn’t pick up on that. change of tone.
Leave one to conclude that the rally in the equity market and QQQ was a de-risking event that led to implied volatility moving lower in a long 3-day weekend. It means there is a good chance that hedging will start on Tuesday and implied vols will start to rise again.
Is it possible that the buying frenzy on the QQQ and the stock market will continue for a few more days or even weeks? Of course. But it depends on how the markets see the volatility next week, after the long holiday weekend. Suppose investors start to feel satisfied with the path of monetary policy. In that case, the demand for protection could fall further, pushing down implied volatility, which may help drive 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 closely track each other, so I’ll be using the VIX going forward as it’s better known and followed as the measure of implied volatility.
The VIX, since early May, has found itself bottoming out around the 25-26 level. It makes that 25-26 region critical; If the VIX continues to push lower on various macro data points this week, such as the ISM manufacturing PMI and the BLS jobs report, there is a strong possibility that the market could rally further. However, if the VIX starts to rise above 30, all of last week’s gains will be wiped out.
There is a good chance that the VIX will go back up this week. As of December, the jobs report has become much more critical of the market, as noted by the VIX. Employment reports for December, March and May showed that the VIX was at the upper end of its trading range. Meanwhile, reports for January, February, and April found the VIX lower.
The fluctuations in the VIX could be because the FOMC meeting in January had very low expectations for any policy changes, while there was no FOMC meeting in February. Also, like the other months, the April jobs report was of little importance as there was no FOMC meeting. June will feature an FOMC meeting, which likely means there will be significant significance to this jobs report, which could be enough for traders to look to hedge again this week’s report.
Not only do these factors present challenges to a sustained long-term rally, 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 as loosening too much, the Fed is likely to step up its rhetoric and start pushing the market where it wants. This would mean that financial conditions are becoming neutral and potentially tightening over time based on how the Fed minutes are read. That is what poses the most significant risk to the QQQ, and will make fighting the Fed a challenging task.