Markets are already reacting to Greece’s rejection of Europe’s latest bailout offer, and it’s not pretty to watch.
The euro fell after Greek voters said “no” to the offer by a big margin in a referendum on Sunday, backing their left-wing prime minister’s call to reject austerity.
The scale of the rejection caught markets by surprise. The currency dropped by more than 1% against the U.S. dollar to trade at around $1.10. U.S. stock futures were down about 1.5% around 6:30 pm ET.
Investors will also pay close attention to bonds issued by European governments. Some analysts say U.S. Treasuries could rally as investors look to avoid risk.
The vote could trigger a series of events that leads to Greece becoming the first country to leave the euro.
Here’s why: Greece is on the brink of going bust. It urgently needs money to pay pensions and wages, and to reopen its banks — shut for a week already after talks with its creditors collapsed.
Related: What ‘No’ vote means for Greece and Europe
If Europe isn’t prepared to relax the terms it was offering Greece just last weekend, and there’s no indication it will, Greece will have to start printing its own currency soon.
On the other hand, if Europe compromises and agrees to write off some of Greece’s huge debt, the credibility of the currency will suffer.
“Whatever the outcome of the next few days, there is no way that the eurozone or the single currency can come out stronger as a result,” said Simon Smith at FxPro.
The risk of fallout from Greece’s collapse directly hurting other European countries is relatively small. Most of its debt is held by governments who could cope with default.
But it will take the eurozone — the bloc of 19 nations that use the euro — into uncharted waters.
It also sets a bad precedent. Membership in the euro was supposed to be a one-way street. In fact, there’s no rule book to manage a member country going bust and crashing out.
It’s hard to imagine any other country choosing to follow Greece into the economic abyss, but some weaker eurozone economies may pay the price in permanently higher borrowing costs if a ‘Grexit’ materializes.
Related: Central banks prepare for the worst
The uncertainty of the next few months could also weigh on European business confidence at a tricky time. The eurozone economy (except Greece) is recovering nicely, but investors are worried about the impact a slowdown in China will have on exports.
Central banks have been preparing for the worst. The European Central Bank unveiled a significant new weapon in its armory last week, when it said it may buy the bonds of a number of companies in vulnerable eurozone countries such as Italy, Portugal and Spain as part of its massive stimulus program.
“If the ECB says it is [going] all in, we could see a sharp bounce in all assets except the euro,” noted Steven Englander, a strategist at Citi.
