As an economics graduate, as opposed to a student in business school, I learned the standard canonical explanation of exchange rate determination thanks to the Krugman and Obstfeld text.
In the short term, the primary determinant is interest rate parity IRP; in the long term it is Purchasing Power Parity PPP.

These work well as both a theoretical framework and a common sense analysis.

Currency traders, however, need not solve the rigorous mathematical problem to be successful in their trade. In fact, they dont have time to do it. They are up all night following the FOREX markets from Tokyo to New York to London. And it is their trading decisions, necessarily made in seconds, that have the greatest effect on the price of the dollar, the yen, and the euro. So you are quite right to factor in emotion and psychology in the movements of these currencies. The dollar”s fluctuations of late have more to do with their decisions than with fundamentals. I thought the euro would take a bigger hit over the troubles at EADS Airbus than it actually did, but apparently short term trading decisions predominated over long term forecasting. Recent moves by the fed on interest and the subprime lending crisis have motivated traders to sell dollars and buy euros. Still, in finance our paramount concern is ROI or Yield to Maturity, although in the currency markets, “maturity” may be only a matter of seconds.
The long term factors, however, look better for the dollar. If the dollar has sunk more this morning, the Eurozone may have a higher real GDP than the United States. Still, the US has a higher aggregate GDP in PPP than the Eurozone, and other fundamentals of the US economy are strong. For one thing, eurozone inflation in food products is high. According to PPP analysis, this would put downward pressure on the euro over the medium term. More important is the issue of labor market flexibility. The US has already gone through a lot of the pain of labor market rationalization, this adds efficiency to American business activities and its effect on productivity and GDP growth, and thus gives the dollar buoyancy in the medium and long term. In Europe, by contrast, labor market reform is being strenuously resisted and this should give euro supporters some cause for concern.
Matthew Hartogh