Strategists say even though the markets expect a no vote in Italy on Sunday, gauging the immediate reaction has been difficult.
"Italy is the biggest wild card. We'll have to see how the referendum goes and more importantly how do markets in Italy respond to that whether or not there's a big jump in perception of risk among Italian financial names," said Boris Rjavinksi, director, rate strategy at Wells Fargo.
Italy is also being watched as one of a number of European countries where voters in coming months could favor nationalist themes and populist movements, in the aftermath of the U.K. Brexit vote to leave the European union. Austria, for instance, has an election on Sunday, and the right-wing presidential candidate has been leading in the polls.
In Italy, the referendum is not an election but it has turned into a vote of confidence in Italian Prime Minister Matteo Renzi. Renzi, a reformer, has proposed constitutional reform that would change the structure of government by reducing the size and makeup of the Senate and centralize more powers. The current system, with votes needing to pass both a large Senate and lower House, has resulted in years of gridlock. Renzi has said he would step down if there is a no vote, but it's not clear whether he would.
"The polls are suggesting a no vote. In contrast, with Brexit and Donald Trump, the polls were suggesting the opposite. The surprise result would be a yes vote, and in that scenario you would expect to see some very big moves in the assets exposed to that. You've seen significant underperformance of Italian banks in recent months, and going into this referendum, you've seen spreads between [Italian bonds] and bunds widen," said Richard Turnill, global chief investment strategist for BlackRock.
Turnill said even though the markets are expecting a 'no' vote, there could still be a reaction. "I think you'd see it particularly in the Italian banks. I think you'll see it in the spreads of Italian bonds over German bunds, and you could potentially see it in the euro. The lessons of Trump and Brexit is not to overestimate the market reaction," said Richard Turnill, "We really don't see the Italian referendum leading to significant financial contagion, even in Europe."
Marc Chandler, chief fixed income strategist at Brown Brothers Harriman, said based on this past week's actions, the market response could also turn out to be relatively calm. If Renzi steps down, he said he would be replaced by a technocrat from his own party who would be in office until the next election in 2018. But Chandler said the risks are that the vote could enable the populist Five Star party to gain ground in the 2018 election. That party, led by a former comedian, is opposed to the euro, and if it does succeed, it could be a major upset down the road for financial markets and Italy's banking system.