European markets are braced for a wave of contagion from Greece on Monday, with heavy losses for southern European government bonds and regional stock markets expected as investors scramble to discount a possible "Grexit" that most had still assumed was unlikely as late as Friday afternoon.
Greek Prime Minister Alexis Tsipras late on Friday surprised creditors by calling a snap referendum on what he said were the unacceptable terms offered to keep the country from bankruptcy.
Greece's European partners on Saturday shut the door to extending the existing credit lifeline beyond Tuesday night’s deadline, an extension that would have accommodated the planned July 5 referendum. The European Central Bank on Sunday then capped the amount of emergency financing it extends to Greek banks at last week’s levels despite reports of further heavy deposit withdrawals over the weekend.
Without new bailout funds, Athens is due to miss a 1.6 billion euro ($1.8 billion) repayment to the International Monetary Fund on Tuesday. And without further increases in ECB emergency to Greek banks, which is likely contingent on Greek banks being deemed solvent and the Greek government being in a bailout program and not in default, Athens may impose capital controls and keep its banks shut on Monday.
"If Greece has to put capital controls in place, that is going to have a real big impact on markets and that will generate increased volatility," said Ian Stannard, European head of FX strategy at Morgan Stanley in London.
Conspicuous by its absence so far from this year's Greek drama has been contagion to other "peripheral" euro nations government bond markets as was the case during the last peak in Greek and euro tensions in 2012. Greek yields have soared, those of Italy, Spain and Portugal have not.
But that could well change on Monday, said analysts, unless the ECB takes measures to contain it.
"There is a risk that peripheral government bond spreads surge to stress levels," wrote ABN Amro analysts in a research paper. "The ECB needs to be ready to activate its OMT (outright monetary transactions) program to restore calm if necessary."
Goldman Sachs said earlier this year that a Grexit could see Italian and Spanish 10-year bond premia over Germany almost trebling to as much as 400 basis points - a shock to all related European financial pricing although still some 200 basis points shy of peaks hit during the winter of 2011/12.
Last week, Goldman said the euro could drop three full cents immediately after a Greek default but a further 7 big figures over the following weeks as the ECB stepped up its anti-contagion bond buying programs of OMT and quantitative easing.
And it's these possible anti-contagion measures that make trading bonds and stocks at least fraught with difficulty over the coming week – and not a simple one way bet on the shock. What's more, the traditional safety of German government bonds in such a crisis has been challenged due to severe liquidity shocks in that market this year also.
Safe-havens outside the euro zone, as a result, may well get a bigger boost. These include the Swiss franc and U.S. Treasuries, with the financial stress creating a dilemma for the Swiss and possibly even the U.S. central bank.
"We would put a high probability on Swiss National Bank intervention" to sell francs for euros, wrote Citi FX strategist Josh O'Byrne.
Even though euro stock prices have held up remarkably well during recent weeks of twists and turns in Greece's debt drama, European stock-market volatility has been propelled to six-month highs and knocked some 4 percent off European stocks since April <.FTU3>.
"We are in uncharted territory and European equities, like all markets, will have a difficult time processing this," said Deutsche Bank Managing Director Nick Lawson.
"The market was not positioned for this going into the weekend and the lack of liquidity that has impacted both sovereign and corporate debt markets, as well as equity recently, will exacerbate things.
In a sign of how volatile markets are expected to be when they re-open, FX broker FXPro said in a note on its website on Saturday that it may limit euro trading to the closing-out of existing positions, and may increase margin requirements on euro pairs "in order to reduce the risk of trading euro pairs".
But the impact of the debt crisis in FX has been less clear than in other markets. The euro last week fell sharply when it appeared that Greece and its creditors were getting closer to a deal, as stocks rose.
"The euro is behaving in an inverse manner to equity markets," said Morgan Stanley’s Stannard, who said the impact on the euro would be determined by just how far risk appetite is affected.
"But if investor sentiment turns even more negative and you get an outright outflow from Europe, then obviously you don’t get that supportive factor and that could leave the euro vulnerable."
Other analysts said the euro, which is currently worth around $1.12 <eur=>, would fall either way, while safe havens, such as the yen, Swiss franc, and even sterling, would benefit.
"We expect the euro lower on the open," said Citi strategist O'Byrne. "When (it) becomes clearer banks are out of cash or that the IMF won’t be paid ... euro could be down more than 2 figures."
(Additional reporting by Lionel Laurent)