First principles always is a good place to start with explaining economics. The Euro has strengthened nicely since mid-July on two major factors. First, the economy is starting to strengthen or at least has stopped the downward slide. Second, and more important are classic lessons in monetary economics. The balance sheet of the ECB is shrinking while that of the Fed still continues to grow. The gap or size advantage to the Fed is getting larger as banks who borrowed emergency funds from the ECB have started to make payments. The ECB has provided forward guidance that they will keep interest rates low, but the quantity side of central banking suggests that funds are a little tighter. This could change if there is an elimination of the current Fed QE buying, but for now the economic headwinds are in favor of the Euro.
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