Does a Euro Breakdown Equal a Euro Breakup?

As the euro falls to new year lows against the dollar, how should we perceive this? Is the market pricing in a breakup or is this just a justified move that is finally occurring on the back of souring sentiment? With German yields falling, talks of a Greek exit rising, and Spanish banks souring by the minute, it seems likely that we are nearing the panic phase of this crisis. However, does panic equate to break up and does a falling Euro signal a full-scale breakup?

This chart may seem familiar, as I posted it a few days ago 'here', the EUR/USD rate has tracked monetary policy rather well. The green line is the cross rate and the blue line is the ratio of the Fed's balance sheet assets to those of the ECB (ignore the scale, for the Fed index is in millions and the ECB index is in billions), and we can see that they tend to move together. Over the last few months, the two have diverged with the euro far higher than one would expect given the recent ECB action. Thus, the move lower seems to be justified and also seems to have room to go.

The real question here is how low can it go? 1.20 seems to be almost magnetic at this point, since we have broken through support levels and currently are making new lows.As you can see on this chart, there appears to be marginal support at 1.25, so that appears to be the short-term target. However, with the Eurogroup summit tonight, it seems reasonable to stay off the table just in case there is some news that creates a quick spike. The Relative Strength Index is yet to show an over-sold reading, even with the CFTC Commitment of Traders Report showing an all-time high in short euro contracts last week. And with the MACD still reading a sell, here is how you should trade the Euro:

After the summit tonight, go short. It is too hard to determine an entry now because a spike may occur on some news. Unless there is a game-changing item that the politicians agree upon later, it is still a good short. I would target the 1.25 level in the short-term and 1.20 in the medium-term. Another way to make a bet on this would be through German bonds. Any indication of Eurobonds or further German-funded spending will send yields higher. However, if you truly believe that a breakup is coming, whether by Germany leaving and causing a breakup from the top or Greece leaving and causing one from the bottom, then German bonds are still an excellent investment because embedded in the low yields is a call option on new Deutsche Marks. This may seem strange, however it makes sense because a breakup will lead to an introduction of new domestic currencies, and Germany would then have to pay its debt off in a new currency. Since the new Deutsche Mark would most likely appreciate significantly against the Euro, owning German bonds represents an inherent call option on a reintroduction of domestic currencies.