The government prepared Wall Street firms on Friday for the possibility it may have to delay or cancel a major round of bond sales if Congress doesn't raise the nation's borrowing limit by August 2.

In a meeting at the Federal Reserve Bank of New York, Treasury officials and representatives from the 20 primary dealers discussed options for the quarterly slate of bond issues if the government runs out of money next week.

Under normal circumstances the government would require around $42 billion in new borrowing through sales of Treasury notes and bonds, but it won't be able to do that without new authority to raise more debt.

Even a delay in the new borrowing, known as the quarterly refunding, could cause fits in the bond market. Investors such as fund managers and short-term traders rely on Treasury securities for activities ranging from securing savings to collateralizing loans.

Indeed, Treasuries accelerated their price gains when news of possible changes to the quarterly refunding became known in the market. The benchmark 10-year note was on track for its largest rally since March 18, 2009, the day the Federal Reserve announced a round of $300 billion in Treasuries purchases, known as QE1.

The options discussed at Friday's meeting included decreasing the amount of the refunding, delaying it, or eliminating it altogether and issuing cash management bills to replace maturing securities, according to sources familiar with the meeting.

There was a general consensus among dealers, the sources said, that it would be better for the Treasury to delay the quarterly refunding rather than cut or cancel it.

The meeting was a higher-profile version of the normal talks Treasury holds with dealers each quarter to discuss debt sales.

Treasury officials confirmed the meeting was originally to be with representatives of around half of the 20 primary dealers -- the 20 large financial institutions that do business directly with the Fed -- but at the last minute it was expanded to include all of the banks and securities firms authorized to deal directly with the Federal Reserve and the Treasury.

Dealers were told not to discuss the details of the meeting, and a readout of the meeting released by the Treasury said only that the dealers agreed swift Congressional action was necessary to lift the debt ceiling.

The Treasury has said if the country's $14.3 trillion debt ceiling is not raised, after Tuesday it will no longer be able to pay all the government's bills and will be at risk of default.

The Treasury is due to announce next week its borrowing needs for the current quarter and its plans for selling debt to meet those needs. But the political debate over whether to raise the debt ceiling has thrown into question how much debt Treasury can sell.

Short-term lending markets have seen the greatest levels of fear, with rates on Treasury debt maturing in August jumping to six-month highs as investors dumped the debt on fears the government may choose not to repay them.

With four days left before the United States hits its debt limit, Republicans pressed ahead with a deficit plan that cannot pass Congress and President Barack Obama told lawmakers to stop wasting time and find a way out of this mess.

(Additional reporting by Jonathan Spicer in New York and Glenn Somerville in Washington; Editing by Burton Frierson and Leslie Adler)

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