Argentina was in a race against time on Wednesday to cut a deal by the end of the day with holdout investors suing it and avert a default, as a surge in the country's bond prices fed optimism that an agreement was possible.

The South American country's economy minister, Axel Kicillof, was expected to speak at the Argentine consulate office in New York after several hours of talks, according to a spokeswoman.

The holdout hedge funds want full repayment on bonds they bought on the cheap after the country last defaulted in 2002, a demand Argentina has so far rejected. Their attorneys, along with an Argentine delegation, met at the offices of court-appointed mediator Daniel Pollack in New York, with just hours to go until the deadline for an interest payment.

Argentina's bonds surged 14 per cent to levels not seen in 3-1/2 years, its stock market hit a record, and the peso rallied, signals to some investors that a deal was attainable before another damaging default.

"It's trading like there's a deal," said a fund manager who holds Argentina's restructured debt and requested anonymity. "I don't have information, but someone knows there's a deal."

In the evening, Standard & Poor's downgraded the country's rating to default, but the bonds did not react.

Latin America's No. 3 economy has for years fought NML Capital, a unit of Elliott Management Corp, and Aurelius Capital Management, the leading U.S. hedge funds that rejected large writedowns. After exhausting legal avenues, it faces its second default in 12 years if it cannot reach a last-minute deal.

The Buenos Aires government has pushed hard for a stay of the U.S. court ruling that set Wednesday's deadline.

Standard & Poor's downgrades Argentina's credit rating

The country has until midnight ET Wednesday to break the deadlock. If it fails, U.S. District Judge Thomas Griesa in New York will prevent Argentina from making the July 30 deadline — representing the end of a 30-day grace period — for a coupon payment on exchanged bonds.

As talks continued, U.S. ratings agency Standard & Poor's downgraded the country's long- and short-term foreign currency credit rating to "selective default," from triple-C-minus and C, respectively. S&P cited Argentina's failure to make a June 30 coupon payment on its discount bonds due in 2033, which it does not rate. The default rating will remain until Argentina makes a payment, the agency said.

"The making of the payment is not an automatic process — it takes time for that to happen," said Roberto Sifon-Arevalo, managing director at S&P.

A consortium of Argentine banks was set to offer to buy out the holdout investors' debt, in an 11th-hour deal aimed at averting a default, a senior banking executive familiar with the offer told Reuters on Wednesday.

The executive said there had not yet been any discussions with the U.S. hedge funds leading the litigation and that the offer would require them to take a haircut, or reduced payment for the bonds.

"The idea is to sit down with the funds and buy all their debt. We have to negotiate the final amount, the terms and how payment will be made," the executive told Reuters.

NML Capital said it had no comment on the banks' proposal.

Argentine president calls hedge funds ‘vultures’

Tough-talking President Cristina Fernandez has called the funds "vultures." Her refusal to flinch in public from her stance that they accept a writedown has split opinion among Argentines at home and abroad.

"We are divided as a family. I think the government needs to settle, and my husband thinks the government is doing the right thing," an Argentine mother of four, who gave her name as Adriana, said while on vacation in New York.

Francisco Sobrero, 69, a tourist visiting New York from Argentina, held up signs outside Pollack's offices in Spanish that translated to "vultures out of Argentina," and "do not take our pound of flesh."

"I want to show my support to the Argentine government" he said.

Argentine economy chief Kicillof's unexpected arrival in New York raised hopes that there was still time to stave off a default that would bring more pain to an economy already in recession, though not the economic collapse seen in 2002 when Argentina defaulted on $100 billion in debt.

During that default, dozens were killed in street protests and the authorities froze savers' accounts to halt a run on the banks.