After Italians decisively rejected his proposal to change the Constitution to make it easier for the government to pass reforms, Prime Minister Matteo Renzi has resigned. The move was widely expected in the markets, and asset prices had been trying to price it in over the past few weeks.
However, on Monday morning the already weak euro fell a further 1.5% to 1.0518, the lowest since March 2015, as Renzi spoke on Italian television. The currency later pared some of those losses to trade at 1.0560 by 7:00 pm ET, was less than 1% weaker by midnight ET and was down just 0.08% shortly before 4 am ET.
U.S. stock index futures were indicating a soft opening for Wall Street shortly after the results of the referendum were known, as fears of political instability in Italy were rising, but later turned positive as the main European indices also turned green.
The leader of the populist Five Star Movement, comedian Beppe Grillo, called for immediate early elections and said his party was ready to govern.
The situation looks bad, but it is not the disaster that many in the markets have predicted when they said a "no" vote would spell the end of the euro.
It is true that, if Grillo's party does get to power, it has promised a referendum on euro membership. But for this to have any effect in law, the constitution would need changing, so it would actually take a while for such a referendum to be organized, if ever.
Plus, if a government formed by Grillo's party does get to power and starts organizing such a referendum, it does not necessarily follow that it would win.
During the campaign, the people will have to listen to some inconvenient truths, such as the fact that abandoning the euro would leave them with debt denominated in a much stronger currency than the one they would adopt.
In simple terms, leaving the single currency would push Italy into a Venezuela-like situation, where the currency fell 60% vs. the dollar in one month alone, and the country just said it would issue banknotes with denominations ranging from 500 to 20,000 bolivars to cope with rampant inflation.
The big worry for investors are Italy's banks, and here the plans to recapitalize the world's oldest bank, Monte dei Paschi (BMDPY) , will be watched closely. The bank planned to raise 5.0 billion euros ($5.3 billion) in fresh capital from investors, and these plans may now be shelved because of market turmoil.
The main issue is that in Italy, banks have sold bonds and shares in themselves to retail investors as an attractive savings vehicle. European Union norms regarding bank rescues that came into force recently call for bondholders and shareholders to be bailed in first, before taxpayers' money is invested in a failing bank.
This would protect Italian taxpayers but would hit these small, unsophisticated investors. It is the equivalent of a political Catch 22, and any incoming government, including populist Grillo's, will have to deal with this dilemma.
All these sound like very serious issues, but there is a silver lining: The European Central Bank holds its last monetary policy meeting of the year this coming Thursday. Investors will again be watching ECB President Mario Draghi's news conference very closely. His promise to do "whatever it takes" to save the euro may again be tested.So far, Draghi did not disappoint. The weakness induced by the Italian referendum could turn out to be a good buying opportunity.