Private creditors said on Sunday they had come to the limits of what losses they could concede in a Greek debt swap, putting the ball in the court of the EU and the IMF in a tense race against the clock to avoid a messy default.
Markets had hoped for an agreement over the weekend, and analysts said they were still betting on a deal, making the market vulnerable if that did not materialize.
"The better news that there will be an agreement has been discounted in the previous two weeks in the markets and so the risk (is) if there is a negative outcome, that will move the markets more profoundly than in case there is an agreement,» Piet Lammens, strategist at KBC said.
"It's not illogical that the Bund is moving somewhat higher. At the end of last week, core bonds finally fell prey to a correction."
The German Bund future rose 16 ticks to 138.28 even as some riskier assets rose. The Bund sold off sharply in the previous two trading sessions.
The 10-year German government bond yield was down 1.6 basis points at 1.91 percent.
Italian and Spanish bonds were higher on the day. Italian 10-year government bond yields fell 4.7 bps to 6.21 percent and the Spanish equivalent shed 4.1 bps to 5.2 percent.
"The market still seems to think they are going to come up with something I suppose. I remain skeptical,» a trader said.
After several rounds of talks, Greece and its private creditors are converging on a deal in which private bondholders would take a real loss of 65 to 70 percent on their Greek bonds, officials close to the negotiations said..
"I think that officials will not push for more haircut, I think they will accept. But of course if they don't accept then there is a crisis and a hard default and that would be very negative for the riskier markets and positive for the Bund market,» Lammens said.
The uncertainty over the outcome of the meeting was making for a more favorable backdrop to the sale of German and French treasury bills later in the session.
"I don't expect any problems getting them away, because they are short-term,» Michael Hewson, market analyst at CMC Markets said.
Short-dated auctions in the euro zone have benefited from nearly half a trillion euros injected in the financial system by the European Central Bank in December.
The outcome of Greece's negotiations with private creditors could also be decisive for appetite at a sale of long-term German and Dutch government bonds later this week.