"We are not convinced by a number of suggestions offered for the EUR’s resilience to wider USD strength. One idea is that EUR is gaining on the basis of its improving current account balance. Yet the US deficit has seen an even greater correction in its imbalance. In addition, the swing into surplus for the Eurozone reflects economic weakness or collapsing domestic demand not strength. The second suggestion is that the EUR is being supported by portfolio flows, but the Eurozone is not the only market to see buying of local equity and bond markets. Furthermore, portfolio flows are not the dominant aspect of the Eurozone’s capital account.
So in the end, the EUR continues to be a “carry trade” where currency movements are largely determined by movements in relative rate expectations. Chart 10, for example, shows EUR-USD in black plotted against the expected gap between Eurozone and US 3M interest rates by the end of 2015. The link may not be perfect, but it is strong. The EUR-USD exchange rate will be determined by the policies of the ECB and Fed, a data-determined evolution, and one we continue to believe will see EUR-USD much lower over this year."
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