Greek shares slid more than 2 percent in early Tuesday trade and government bond yields rose after euro zone finance ministers failed to agree on debt relief for Greece with the International Monetary Fund on Monday and did not release new loans to Athens.
Greece had hoped for clarity on more debt relief after legislating reforms, including painful pension cuts and tax hikes, demanded by its official creditors but the Eurogroup meeting in Brussels failed to reach an agreement.
The IMF has been pressing the euro zone for more detail on actions it could take, if necessary, to contain Greece's gross financing needs, based on a May 2016 declaration.
But the euro zone is holding back on making such promises now. At 0912 GMT Greece's benchmark stock index was trading 1.37 percent lower, trimming earlier losses of 2.25 percent, with bank shares shedding 3 percent.
Stocks had rallied 18 percent since late April on expectations that the wrap up of a bailout review and a deal on debt would pave the way for Greece to be included in the European Central Bank's bond-buying program.
Greece's short-dated government bond yields spiked in early Tuesday trade. The yield on the two-year bond maturing in July this year spiked 24 basis points to 5.73 percent, and the 10-year bond yield was up 7 bps on the day.
"It's a reaction to false expectations that there would be white smoke, cultivated by the press and the government," said the treasurer of a Greek bank, declining to be named.
"The solution to Greece's debt problem cannot hinge on a date but on a long-term contract.
The IMF wants specificity on certain parameters to be able to conclude that the country's debt can be sustainable," he said.
Greece's debt burden after restructuring privately held government bonds in 2012 and three bailouts is projected at 319 billion euros this year or 176 percent of its economic output.
Talks on debt relief are based on a promise by the Eurogroup in May 2016 to stretch maturities and grace periods on loans so that Greece's gross financing needs are below 15 percent of GDP after 2018 for the medium term, and below 20 percent later.
Euro zone lenders may consider replacing more costly IMF loans to Greece with cheaper euro zone credit and transfer profits made from a portfolio of Greek bonds bought by euro zone national central banks back to Athens.
"The solution on debt is a very complex and technical discussion. Without concrete signs of an agreement at a technical level, expectations of a deal at yesterday's Eurogroup were too optimistic. The market reaction is not extreme," said Ilias Lekkos, chief economist at Piraeus Bank.