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US Senate Majority Leader Harry Reid and Senate Republican leader Mitch McConnell said leaders had come to an agreement, which will reopen the government that has been shut since October 1, and raise the debt ceiling until February. The House of Representatives planned to vote on the measure later in the day.
The final passage may come after the Treasury's Thursday deadline for being able to borrow, but news that a deal had emerged was enough to soothe markets, which have been roiled by the Washington impasse. US stocks shot up more than 1%, putting the S&P 500 just below its all-time closing high.
"It looks like we'll get through this, which brings the (stock) market a bit of a reprieve. Not only is this a relief rally, but we're still in an environment with a very accommodative monetary policy, which provides a tailwind," said Judy Moses, portfolio manager at Evercore Wealth Management in San Francisco.
Days of political wrangling over the US budget and the debt limit also sparked substantial preparation by dealers in government securities for the possibility of a default.
A missed coupon payment would reverberate through the short-term repurchase market, a key source of overnight funding for banks and other institutions that depend on the use of Treasury securities as collateral.
That market was effectively shut when Lehman Brothers collapsed in 2008 and endured severe strains in 2011 during the previous debt ceiling crisis.
Some have compared the situation to the extensive preparations to prepare technology systems for the so-called Y2K millennium bug in 2000, as well as to the fiscal ceiling debate in 2012.
"People were staying up all night worried about what would happen during (the Y2K) deadline. Then nothing happened," said David Keeble, global head of interest rate strategy with Credit Agricole Corporate & Investment Bank in New York.
"In this case, all the switching out of T-bills and dealings with repos would be for naught if we don't default."
The situation also resulted in much volatility in the near-term Treasury bill market, which is more sensitive to the debt limit.
Yields on Treasury bills that come due later this month fell on reports of a deal, after skyrocketing in the morning. Interest rates of bills that come due in February rose, however, as issues over the debt ceiling again look likely to be raised in that month.
Debate over the debt ceiling and reduced activity from the partial government shutdown are seen as harming the economy just as the Federal Reserve is likely to begin paring back its $85 billion-a-month bond purchase program.
Yields on bills due on October 24 fell to 0.26% in highly volatile trading, after getting as high as 0.72% earlier on Wednesday. Rates on Treasury bills maturing on February 13 rose by as much as 0.14% on Wednesday, up from 0.05% on Friday.
Also, the gaps between bid and offer prices in the short-term rates market and the repo market increased, widening to about 10 basis points. They normally trade around a 1-basis-point gap. Activity in the repo market was quiet, according to brokers, because traders were waiting for the outcome of the negotiations in Washington.
On Wall Street, the Dow Jones industrial average was up 205.82 points, or 1.36%, at 15,373.83. The Standard & Poor's 500 Index was up 23.48 points, or 1.38%, at 1,721.54. The Nasdaq Composite Index was up 45.42 points, or 1.20%, at 3,839.43.
The CBOE Volatility index, Wall Street's fear index, fell 21% to 14.71 in its biggest one-day decline since August 2011.
MSCI's world equity index, which tracks shares in 45 countries, was up 0.7% at 389.82, not far from a five-year peak of 391.54 hit on Sept 19.
Even though the consensus view among investors had been that a deal would eventually be reached, investors have had reason to worry.
The owners of more than 20 US Treasury securities were seen most at risk, with the Fed almost certainly the largest holder.
Citing the debt ceiling impasse, Fitch Ratings late on Tuesday warned it could cut the US sovereign rating from AAA.
Without a deal on the debt issue, the US government would by law no longer be able to add to the national debt and would have to rely on incoming revenue and about $30 billion in cash to pay the country's many obligations.
That money would run out quickly and the government would start missing payments in the weeks ahead.
DEAL TALK ALSO BOOSTS US DOLLAR, OIL
The dollar rose against most currencies after the announcement in Washington. The dollar was up 0.7% against the yen at 98.81. It hit a high of 98.97, the highest since Sept 27. The dollar index was flat on the day at 80.507, peaking at 80.754, the highest since Sept 18.
Oil prices also rose on the deal talk. Brent crude futures gained 90 cents to settle at $110.86 a barrel, while US crude oil futures gained $1.08 to $102.29.
Gold prices edged lower after the news, though losses were limited as physical buying in Asia and the United States emerged. Spot gold was down 60 cents, or 0.05% at $1,279.64 an ounce.
