GLOBAL MARKETS-Stocks, dollar hit by budget showdown, debt ceiling worry
* U.S. government still shut down; debt ceiling deadline looms
* U.S. 1-month T-bill rates highest since November
* Wall Street slumps; dollar hits eight-month low
NEW YORK, Oct 3 (Reuters) - Major stock markets lost ground on Thursday and the dollar hit an eight-month low as worries grew that the budget standoff in Washington would drag on and become intertwined with the looming and more complex fight over raising the U.S. borrowing limit.
U.S. stock indexes fell about 1 percent as the partial U.S. government shutdown entered a third day and after President Barack Obama maintained his defiant tone by reiterating in a speech that he would not meet Republican demands to scroll back provisions of his healthcare reform in exchange for reopening the government.
Wall Street briefly extended its losses and the dollar dropped on reports that gunshots were fired at the U.S. Capitol, but the moves were reversed after news that the shots were fired outside the building.
Analysts expect investor patience to run out if the government shutdown lasts more than about a week as the debt ceiling deadline approaches. U.S. Treasury Secretary Jack Lew has said the United States will exhaust its $16.7 trillion borrowing authority no later than Oct. 17.
Failure to raise the debt limit could damage not only the United States but the rest of the global economy, International Monetary Fund chief Christine Lagarde said. Concerns about a U.S. default have driven up the cost to insure Treasuries, while U.S. one-month Treasury bill rates hit their highest level since November.
"The fact is that every day we are looming closer and closer to the debt ceiling issue, which is the real concern," said Randy Frederick, managing director of active trading and derivatives at Charles Schwab Corp. in Austin, Texas.
"While market losses haven't been too big during shutdowns, we did retreat about 17 percent in summer of 2011 just before raising the debt ceiling."
MSCI's world equity index, which tracks shares in 45 countries, fell 0.4 percent to 382.66. It has lost more than 2 percent since its recent high on Sept. 19.
The Dow Jones industrial average ended down 136.66 points, or 0.90 percent, at 14,996.48. The Standard & Poor's 500 Index fell 15.21 points, or 0.90 percent, to 1,678.66. The Nasdaq Composite Index dropped 40.68 points, or 1.07 percent, to 3,774.34.
Stocks and Treasury yields bounced off the day's lows after The New York Times reported that House of Representatives Speaker John Boehner said he was determined to prevent a government default.
A spokesman for Boehner, the top Republican, said he has always said the country will not default on its debt, but that there are not enough votes in the chamber to pass a debt limit hike without added provisions.
Market volatility could increase if the deadlock continues as concerns about the economic impact increase. Goldman Sachs estimated a short-term shutdown would slow U.S. economic growth by about 0.2 percentage point, while a weeks-long disruption could weigh more heavily - 0.4 percentage point - as furloughed workers scale back personal spending.
The dollar fell 0.2 percent against a basket of currencies , having touched an eight-month low of 79.627, on views that the shutdown diminishes the chances of the Federal Reserve reducing monetary stimulus this year. The euro firmed 0.3 percent to $1.3619.
European shares dropped 0.4 percent to close at 1,242.18.
U.S. DEFAULT RISK
Short-term U.S. Treasury debt yields rose on fears that lawmakers would not raise the debt ceiling before a mid-October deadline, which could wreak havoc in key funding markets.
That worry was seen in the inverted bill yield curve, with one-month bills set to mature on October 31 - two weeks after the date the debt ceiling must be increased - having risen above six-month bill rates. The rate on that bill touched 0.17 percent on Thursday, highest since November, compared with a 0.03 percent rate for the issue that matures one week later.
The cost to insure U.S. government debt also soared. Investors would pay about 46,000 euros to insure 10 million euros worth of Treasuries for a year on Thursday, according to Markit. That was the highest premium on one-year U.S. sovereign debt since July 2011 during the first debt ceiling showdown between Obama and top Republican lawmakers.
Benchmark 10-year Treasury notes were up 2/32 in price to yield 2.61 percent.
U.S. data earlier showed the number of Americans filing new claims for jobless benefits edged up last week, while growth in the U.S. services sector cooled last month.
The Labor Department said the government's employment report for September will not be released as scheduled on Friday due to the shutdown; a new release date had not yet been set.
Spot gold traded little changed $1,316 an ounce.
Oil prices fell on concern the U.S. government shutdown will hurt energy demand. Brent crude was down 19 cents to settle at $109.00 a barrel. U.S. oil fell 79 cents to settle at $103.31 a barrel.