* Short-term bill, credit market edgy as debt deadline nears
* One-year debt insurance costs highest in over two years
* October bill rates rise further above 2-year T-note yields
* U.S. 10-year yields stable on signs deal may be near
By Emelia Sithole-Matarise
LONDON, Oct 16 (Reuters) - The cost of insuring against a near-term U.S. default and rates on October Treasury bills jumped on Wednesday on concern lawmakers may not reach a deal to lift the federal debt ceiling before the government runs out of cash.
The increased tension in short-term debt and credit markets came after expectations that a deal could be announced late on Tuesday were not met. However, the broader Treasury market was largely steady after Senate leaders were said to be close to agreeing a deal that would also reopen the partially shut government.
"A deal looks closer but it's not done," said Nick Stamenkovic, a strategist at RIA Capital Markets in Edinburgh.
"Whilst Treasuries are pretty stable there's nervousness at the short end. Investors are worried that if there was the worst case scenario and a technical default were to occur, their payments may be delayed. Hence we have seen a sharp rise in yields and worsening liquidity at the short end."
The government's borrowing authority is set to run out on Thursday and if no deal is reached by then, a default could quickly follow, freezing the U.S. financial sector and potentially harming the global economy.
Reflecting the near-term threat, the cost of insuring one-year debt against default jumped to its highest since July 2011 at 75 basis points while five-year rates were unchanged at 37 bps, according to data provider Markit.
The one-year rate has surged more than tenfold from 6 bps in early September, taking it 38 bps above the five-year rate.
The cost of buying longer-term credit protection is normally higher than for short-term cover.
Rates on bills maturing in October were above 0.50 percent, some 15-20 bps more than two-year yields. Yields on bills maturing in November were also up.
U.S. 10-year T-note yields were steady at 2.72 percent while T-note futures were flat at 125-55/64.
Despite the short-term default risk, investors have bought U.S Treasuries, the world's most liquid debt securities, as a relatively safe asset and because any disruption to payments would be temporary.
"If you're afraid of a U.S. default what do you do? There's no obvious answer because Treasuries tend to rally," said Ciaran O'Hagan, rate strategist at Societe Generale in Paris.
Citigroup said on Tuesday the bank no longer holds any U.S. Treasury bills that mature before Oct. 31.
"The market is pricing in that the U.S. will get the situation sorted. (But) nervousness in the short end continues. The Oct. 24 bills have been the whipping boy of the market," one London-based trader said.
"I'm not seeing a lot of flow at the moment. I saw guys wanting to sell them but then the bids kept backing up. You can technically short them but no one is going to take them as collateral so I'm not seeing any of that stuff."