EL-ERIAN: Here's how the markets will respond to this weekend's debacle in Greece

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Given developments over the last 36 hours — including the announcement of a Greek referendum in the midst of a massive setback to the country’s relations with its European partners and the IMF — financial markets will open on Monday realizing that Grexit is no longer unlikely or just a possibility; it is now probable.

That same day, lines that started forming on Saturday as citizens withdrew money from ATMs will develop into heavy bank-deposit withdrawals and accelerated capital flight out of Greece. The government will have no choice but to seriously ponder the imposition of capital controls. It may also need to consider some types of restrictions on normal banking activities.

And this would be just the first set of disruptions in what promises to be a precarious week for the country that includes defaults on debt and suppliers.

What about the impact on financial markets?

Investors in Greek securities need to brace for a sharp selloff in the stock market, with bank shares particularly hard hit. Fixed income will not be spared. Yields on Greek government bonds are likely to soar as investors price in higher default risk.

The extent to which this spills over and disrupts other markets is function of what European officials do to strengthen the firewalls that limit financial and technical contagion.

Should nothing new be announced by the time markets open on Monday, yields on peripheral European bonds (including Italy and Portugal) would widen, the prices of corporate and emerging market bonds would also fall, and equities would decline around the world. This would be accompanied by a flight to quality, compressing yields on German and US government bonds.

The threat of such contagion could be materially reduced if European officials were to react preemptively. For example, a willingness by the European Central Bank to expand its asset-purchase program would help reduce anxiety about parallels to the “Lehman Moment,” thereby limiting the widening of peripheral spreads and the fall in other risk assets. It would, however, result in a depreciation of the Euro.

What about the investment implications?

They would be quite straightforward — namely, for investors to “buy on dips” non-Greek assets possessing sound fundamentals — if most securities were not already trading at quite elevated prices due to sustained and meaningful central bank support. But they are. As such, investors would be well advised to wait for further technical shakeouts before committing significant resources.

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