Follow the money (supply)

This begs the question, of course, as to what drives the interest-rate expectations embedded in the money market curves. The answer, unsurprisingly, is money. The U.S. money supply (as measured by M2) grew far more rapidly than did its European counterpart from late 1999 through late 2002, a period of EUR weakness. Once the American economy started to recover after the bear market lows of October 2002, the situation reversed: European M2 growth greatly outpaced that of the U.S. all through 2005. As a result, the EUR weakened and the EUR’s FRR increased relative to the USD’s FRR.