"Congressmen and women are coming to terms with how calamitous it would be if the debt ceiling was not raised," said Joseph Tanious, Global Market Strategist for J.P. Morgan Asset Management. "Cooler heads are prevailing."
The Dow rose as much as 310 points, or 2 percent, to 15,113 in late afternoon trading.
The surge broke a three-week funk in the market. Stocks have steadily declined since mid-September as Washington's gridlock got investors worried that the U.S. could default on its debt and wreak havoc on financial markets. As of Wednesday, the Standard & Poor's 500 index had fallen 4 percent from its all-time high of 1,725 reached on Sept. 18.
On Thursday, the S&P 500 jumped as high as 36 points, or 2 percent, to 1,692.
The gains were extraordinarily broad. Of the 500 stocks in the S&P 500 index, only 13 fell. Banks and industrial stocks rose the most.
The Nasdaq composite index added 86 points, or 2.3 percent, to 3,764.
A potential compromise between the two political parties could not come soon enough. Treasury Secretary Jack Lew has said the government will hit its borrowing limit on Oct. 17. That would leave the U.S. with enough cash to last just a week or two before a default became a real risk.
A short-term extension of the debt limit is "the right approach," said Jack Ablin, who manages $66 billion as chief investment officer at BMO Private Bank. "It allows politicians to turn down the heat a bit while still keeping the broader issues on the front burner," Ablin said.
In another bullish signal, small-company stocks rose even more than the rest of the market. Those stocks tend to be riskier than large, well-established companies but can also offer investors greater rewards. A sharp increase in small-company stocks means investors are more comfortable taking on risk. The Russell 2000 index jumped 15 points, or 1.4 percent, to 1,058. The Russell is just 20 points below an all-time high it reached Oct. 1.
There were hopeful signs in the market for short-term U.S. government debt. The yield on the one-month Treasury bill eased to 0.25 percent from 0.27 late Wednesday.
The yield had spiked from near zero at the beginning of the month to as high as 0.35 percent Tuesday as investors dumped the bills out of concern that the government might not be able to pay them back when they're due. Investors demand higher yields when they perceive debt as being risky.
On major investor made a move to cut its exposure to short-term U.S. government debt. Fidelity Investments, the nation's largest money market fund manager, said Wednesday it had sold all of its short-term U.S. government debt.