As fears that the Eurozone would implode continued to build throughout late 2011 and the first half of 2012, the euro lost nearly 20% of its value relative to the dollar.\u00a0 But as fears of a meltdown receded, the euro rallied, notching up gains of about 13% vs. the dollar before settling into a trading range that has lasted for most of 2013.<\/p>\n So, where does the euro go from here?<\/p>\n There are a lot of moving parts, but let\u2019s look at some of the most critical drivers one by one.<\/p>\n 1.All else equal, an improving Eurozone economy should\u00a0 give investors faith that the worst is over for Europe.\u00a0 Improving sentiment means new money flowing into Europe\u2026which should point to a stronger euro.\u00a0 On this count, we see what could be the first green shoots of recover.\u00a0 European oil consumption is rising for the first time in two years, and the Spanish unemployment rate\u2014though still shockingly high at 26.3%–ticked down for the first time in two years last quarter.<\/p>\n 2. The \u201ccarry trade\u201d is a major determinant of currency moves.\u00a0 All else equal, higher-yielding currencies tend to rise relative to lower-yielding currencies.\u00a0 Currency traders short the lower-yielding currency and buy the higher-yielding currency, hoping to profit both from the spread between the two interest rates and from appreciation in their long currency.\u00a0 Right now, the Fed Funds rate is effectively zero (it\u2019s official target is 0.00% \u2013 0.25%).\u00a0 Bernanke has indicated that rates will remain close to these levels for \u201cthe foreseeable future,\u201d which is taken to mean through at least the end of 2014.<\/p>\n The ECB\u2019s target rate is slightly higher, at 0.50%, but not high enough for the spread to be much of a factor.\u00a0 At best, the euro is slightly less likely to be used as a funding currency than the dollar or yen.\u00a0 Overall, I consider the carry trade to be neutral for the euro.<\/p>\n 3. Lower inflation generally leads to an appreciating currency, all else equal.\u00a0 And on this count, I see a mild positive for the euro.\u00a0 Inflation in the Eurozone can in at 1.6% last month, and core inflation was just 1.2%.\u00a0 In the U.S., the numbers were 1.8 and 1.6, respectively.\u00a0 I expect inflation to remain tame in both the U.S. and Europe, though when inflation does eventually start to trend upward again I expect it to happen in the U.S. first.<\/p>\n 4. A positive trade balance is good for a currency, all else equal, and this metric favors the euro.\u00a0 While five years of economic malaise have brought the American current account deficit down to just 2.7% of GDP<\/a>,\u00a0 the Eurozone has a current account surplus of about 2% of GDP<\/a>.<\/p>\n The numbers suggest that the euro should enjoy modest gains against the dollar over the next year, or at the very least continue to trade near the upper end of its recent trading range. \u00a0Of course, all of this could go out the window in an instant if Italy or Spain slide into political crisis again or if the bond markets revolt as they did early last year.<\/p>\n Trading \u201cnear the upper end of its recent trading range\u201d is not a ringing endorsement of a long-euro trade.\u00a0 But given the likelihood of relative stability in the euro, a strong case can be made for European equities.\u00a0 Taken as a group, European stocks are substantially cheaper than their American counterparts<\/a> and tend to pay higher dividends.<\/p>\n This article fist appeared on MarketWatch.<\/p>\n SUBSCRIBE\u00a0<\/b><\/a>to\u00a0Sizemore Insights<\/em>\u00a0via e-mail today.<\/p>\n![\"EURUSDred\"](\"http:\/\/charlessizemore.com\/wp-content\/uploads\/2013\/07\/EURUSDred.gif\")
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