The QQQ ETF Rally Is Ready To Melt (NASDAQ:QQQ)

The Nasdaq 100 (QQQ) raced off their lows as a function of an illiquid market, plunging real rates and short covering, resulting in a very rapid rise. If this is the correct assessment, the rally we have seen will likely be given back.

On Thursday, the rally off the lows was driven by a massive flight to safety, which dramatically lowered rates across the yield curve. It also sent real yields down. The US 5 YR TIP fell to around -1.45% from -0.95% in nearly a straight line very early Thursday morning. Why do we care about real yields? Because we know that when rates drop, it results in investors and algorithms flocking to high growth names, which put an instant bid into QQQ ETF once regular trading opened.

The TIP ETF is a good way to track the direction of real yields during the day, with a rising TIP price indicative of falling real yields and vice versa. The QQQ ETF started to trade higher due to these plunging real yields.

Once the rally started, the QQQ was off to the races, which sent traders scrambling to sell their put options, sending the VIX plunging. Once that happened, the race was on as put sellers forced market makers to unwind their hedges and start buying the ETF and index futures.

It’s all amplified because liquidity in the Nasdaq 100 futures has been just as bad, with the depth of book thinning out and spreads widening.

However, once we get past these two days of a classic short squeeze rally, and real yields begin to move higher again, reality should start to set in. The Fed will raise rates and eventually start draining the balance sheet. This means this rally in the QQQ ETF should become a thing of the past and melt away as the longer-term downtrend takes hold.

Downtrend

The downtrend has been solid, and while that can change, for now the channel is holding up very strongly. There’s also a negatively sloping relative strength index that has yet to send a meaningful reversal signal.

The overarching issue for the QQQ remains the Fed and what it plans to do regarding interest rates and how it intends to take excesses out of the economy to bring inflation rates down. Ultimately, the easiest way for the Fed to do this is to have the markets do that for them by jawboning rates higher, which eventually leads to tighter financial conditions and reduces the amount of speculative leverage in the equity market.

While it may not seem as if the Fed would want the QQQ ETF or any other part of the equity market to drop, it would be a significant first step in helping to ease back on inflation as it would result in people probably pulling back on spending.

When thinking about the longer-term picture and beyond the current one or two-day rally, off fairly oversold conditions, it would seem the path for QQQ to reclaim its former glory is heavily stacked against it.