By Barani Krishnan
NEW YORK, Oct 9 (Reuters) - Strains in short-term interest rates and funding markets increased on Wednesday in the feud over the U.S. debt ceiling, but the dollar rallied after the Federal Reserve said the decision not to reduce bond purchases in September was a close call for some policymakers.
On Wall Street, the Dow and S&P 500 ended modestly higher as Republicans and Democrats in Congress said they saw signs of hope for a break in the fiscal impasse in the ninth day of government shutdown.
The Nasdaq added to recent losses as investors cashed out of the year's best-performing technology shares.
Short-dated U.S. Treasury bill yields were higher on increased concern over whether the government will raise the federal borrowing limit by an anticipated Oct. 17 deadline.
Short-term repurchase markets - the plumbing of daily banking operations - saw overnight interest rates rise to their highest in five months on similar fears.
The Federal Reserve's minutes from its September meeting showed that most members of the central bank's policy committee thought they needed more evidence of sustainable economic progress, though the Fed said it was a 'relatively close call' for several voters.
'It's interesting that there would be such a heated debate, since it is painfully clear that the economy is still in such a fragile state that the Fed can't start the tapering process,' said Todd Schoenberger, managing partner at LandColt Capital in New York.
'Some were looking for improvements in data, but clearly the economy can't stand on its own without intervention. Between slow growth and the shutdown, it's clear we're in troubled times. I wouldn't expect any tapering for quarters from now.'
At the close, the Dow Jones industrial average was up 26.84 points, or 0.18 percent, at 14,803.37. The Standard & Poor's 500 Index was up 1.03 points, or 0.06 percent, at 1,656.48. The Nasdaq Composite Index was down 17.06 points, or 0.46 percent, at 3,677.78.
The Treasury sold $21 billion in 10-year notes on Wednesday, the second sale of $64 billion in new coupon-bearing supply this week. It will also sell $13 billion in 30-year bonds on Thursday.
The benchmark 10-year U.S. Treasury note was down 8/32, its yield at 2.6649 percent.
In the latest out of Washington, Republicans and Democrats floated the possibility of a short-term increase in the debt limit to allow time for broader negotiations on the budget.
The slight shift in tone was aided by a column by House Budget Committee Chairman Paul Ryan of Wisconsin, who urged a negotiated end to the stalemate but did not mention Republican demands for linking changes in the federal healthcare law with government funding.
The nomination of Janet Yellen to head the Federal Reserve lent a modest boost to the dollar. The 67-year-old is seen largely sticking to Ben Bernanke's policies aimed at boosting economic activity.
'The markets are finding consolation in Yellen's expected nomination because that at least puts the monetary policy on a more certain, or at least, a more familiar path,' said Anastasia Amoroso, global market strategist at J.P. Morgan Funds in New York.
European shares hit a one-month low. The MSCI's world index was down 0.2 percent.
DOLLAR UP, COMMODITIES DOWN
The dollar rose from an eight-month low against major currencies, riding on the sentiment from Yellen's impending nomination and hopes that U.S. lawmakers will eventually reach an agreement on the budget..F
Congress must come up with a deal by Oct. 17, when Treasury Secretary Jack Lew has said the government will run out of money to pay its bills.
The dollar index was at 80.38, up 0.4 percent. The euro fell to $1.3519, down 0.4 percent on the day.
Against the yen, the dollar rose 0.5 percent to 97.33 yen , moving away from a two-month low of 96.55 touched on Tuesday.
Jane Foley, senior currency strategist at Rabobank, said markets were wary that an eleventh-hour deal could drive dollar higher and thus, no one wanted to be too short the currency.
'There are expectations that as soon as there is a deal in Washington there will be a relief rally in the dollar, so people don't want to be too short of the dollar,' Foley said.
In commodities, global oil prices settled down almost 2 percent at below $110 a barrel on concerns that the budget deadlock would weigh on investor confidence, hurting demand for crude. The spot price of gold was down almost 1 percent at $1,307 an ounce, after hitting a 1-week bottom at below $1,300.
(Additional reporting by Ryan Vlastelica, Richard Hubbard, Anooja Debnath and Toni Vorobyova, Editing by Susan Fenton, Nick Zieminski and Chizu Nomiyama) Keywords: MARKETS GLOBAL/
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