By Joseph Adinolfi, MarketWatch , Hiroyuki Kachi

Markets seen having mostly priced in a negative vote

After falling to a 21-month low late Sunday, the euro was recovering early Monday as investors appeared to move past the initial shock of a "no" vote in the Italian constitutional referendum and the resignation of Italy's prime minister.

One euro bought $1.0701 in recent trade, up 0.3% from $1.0665 late Friday in New York. The currency traded as low as $1.0505 late Sunday, its lowest level since March 16 2015.

On Sunday, Italian voters overwhelming rejected a slate of constitutional reforms. Prime Minister Matteo Renzi, who has led the country since 2014, announced he was stepping down, as was widely expected.

Renzi's decision to resign and the rejection of the "no" vote roiled Italy's embattled banking sector and raises questions about the future of the Italian government and that of the European trading bloc. The fear is that the rejection sets the stage for an early election and perhaps a abandonment of the European Union similar to the U.K.'s vote to exit from the bloc in June.

Some market strategist, however, say the referendum's defeat wouldn't derail the constitutional-reform process in Italy.

"Clearly the referendum was rejected but that doesn't mean efforts to shore up the banking sector, and fix problems with competitiveness and the country's lack of economic efficiencies will end," said Valentin Marinov, chief G-10 currency strategist at Crédit Agricole.

Not only was the euro recovering, but peripheral bond spreads moved lower following a knee-jerk increase, which was seen as a sign that bond investors had also embraced a more sanguine view of the prospects for the Italian banking sector, Marinov said.

The yield on the 10-year Italian government bond fell 2.4 basis points to 2.015%, while the yield on the German 10-year rose 5.8 basis points to 0.339%. Earlier, the spread between the two yields had reached a two-year high.

However, shares of Italian banking stocks held on to their initial losses, with shares of UniCredit S.p.a, Italy's largest lender, down 5.6% at EUR1.97

S&P 500 futures pointed to a moderately higher open for the U.S. stock market, while European stocks advanced as early losses faded.

Italy's FTSE MIB (http://www.marketwatch.com/story/italian-stocks-slump-after-voters-reject-renzi-in-referendum-2016-12-05) opened 2% lower. Italian bank stocks were down more than 3%

Japan's benchmark Nikkei Stock Average closed 0.8% lower (http://www.marketwatch.com/story/asian-shares-fall-led-by-banks-as-investors-rattled-by-italian-referendum-2016-12-05), Australia's S&P ASX 200 declined 0.8%, and South Korea's Kospi lost 0.4%.

As the vote count went on, Renzi admitted defeat and announced he will resign from office (http://www.marketwatch.com/story/italian-prime-minister-to-resign-monday-after-bruising-referendum-defeat-2016-12-04). With more than 90% of votes counted, 59.9% of voters were against the reform, according to Italy's Interior Ministry.

Read: What to know now that Italy has voted 'no,' with Renzi set to step down (http://www.marketwatch.com/story/what-to-know-now-that-italy-has-voted-no-with-renzi-set-to-step-down-2016-12-04)

The euro has fallen sharply since President-elect Donald Trump's unexpected victory in the Nov. 8 U.S. presidential election. Presently, its trading just above lows seen in the early 2000s, shortly after the currency was launched. The euro began life in 1999 trading at $1.17, but spent most of its early life below $1.

While much of its recent drop is due to a stronger dollar, analysts point to the Italian referendum as another key factor.

Indeed, a negative result is a blow to Renzi and his reformist pro-European government, while bolstering the populist 5 Star Movement, currently Italy's largest political opposition, and possibly other euroskeptics across the Continent.

The euro's early reaction was still muted enough to suggest that financial markets had mostly priced in a negative vote in the referendum and are unlikely to seize up.

"We've been short the euro for quite some time," said Gregory McGreevey, chief executive officer of Invesco Fixed Income, who said his firm's bet against Italian sovereign bonds had also delivered good results over the past few weeks.

The extent of the political risk facing the European project will become clearer as the fallout from the Italian referendum unfolds, analysts say. Despite Renzi's pledge to resign, many believe he could be succeeded by a grand coalition, which would keep the 5 Star Movement at bay.

Austria's rejection of populism in Sunday's presidential election is likely to provide some optimism to markets, ahead of a complicated political calendar in 2017. the Netherlands, France and Germany are all facing key elections with euroskeptic parties on the rise.

Still, some said the euro would likely continue to face pressure due to turmoil in global politics.

"Populism is on the rise," said Ben Sy, head of fixed income, currencies and commodities at J.P. Morgan Chase's private bank in Asia, pointing to the U.K.'s vote to leave the European Union, the election of Donald Trump in the U.S. and now the referendum in Italy. "That will undermine the euro as a currency," he added.

In other currencies trading, the ICE U.S. Dollar Index was slightly lower at 100.65 while the British pound was changing hands at $1.2709, ahead of the U.K. Supreme Court's hearing on whether Parliament's consent will be required for the government's Brexit negotiations. Sterling traded at $1.2712 late Friday in New York.

The Wall Street Journal's Saumya Vaishampayan in Hong Kong and MarketWatch's Victor Reklaitis in London contributed to this article.

(END) Dow Jones Newswires

December 05, 2016 08:33 ET (13:33 GMT)

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