As stocks rallied on optimism for a debt deal, traders bid up close-dated Treasury bills, a highly volatile corner of the bond market that looked most fearful of a U.S.default.
Yields on Treasury bills that mature in October—a small but widely watched subset of the market—have been moving dramatically this week. The Oct. 31 dated bill hit a high yield of 0.65 percent Tuesday morning but fell to 0.3 percent by late morning and then to 0.22 percent after Senate leaders announced a compromise bill to reopen the government and avoid the debt ceiling. It had been yielding 0.25 percent Tuesday morning.
"The last hurdle is to see it actually pass the House. It looks to be a very low probability that it won't pass," said John Briggs, who heads cross asset strategy at RBS. Traders had been selling October dated Treasury bills ahead of the midnight deadline for the U.S. to reach its debt ceiling.
"You probably could see another 10 basis points come out of the October bill yields," he said. He noted Nov. 20 bills, auctioned Wednesday morning also rallied.
"The Nov. 20 four-week bill auctioned at 0.24, and it's now 0.135," he said.
Reports Wednesday morning that Congressional leaders would fast track a deal to resolve the government shut down and avert hitting the debt ceiling sparked a major rally in stocks and risk assets.
Even as October and early November T-bill yields snapped higher Tuesday and early Wednesday, traders did not believe the government would default.
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On Wednesday, yields on the one-month, three-month and six-month T-bills all fell sharply, while yields on longer-dated Treasury notes and bonds rose slightly. The yield on the Treasury bill set to mature Nov. 7 fell to 0.12 percent from a high Wednesday morning of 0.44 percent.
The selling in T-bills also coincided with a creep higher in general obligation rates in the repurchase agreement market.
"To me it's just timing and window dressing of not wanting to break the buck. It's the appearance of it," said Peter Boockvar, chief market analyst with the Lindsey Group.
"No one expects them to default," said Boockvar. "It's just the logistical nightmare of trying to prioritize payments. Everyone just assumes there will be a deal, even if it's a minute before the deadline."
Boockvar said the bigger question for markets is where equities will trade once there is a deal.
"What happens to the rally after we get one. We're up 500 points We already had the deal rally," said Boockvar.
—By CNBC's Patti Domm. Follow here on Twitter @pattidomm.