CORRECTED-GLOBAL MARKETS-U.S. short rates jump on default fear, stocks slip
(In paragraph 13, corrects VIX level to Monday's)
* Weak demand for U.S. short-term bills highlights debt worries
* High-flying stocks hit as investors pull back from gains
* Dollar edges off near 8-month low vs major currencies
* World share markets, oil, trade in narrow ranges
NEW YORK, Oct 8 (Reuters) - Interest rates on one-month U.S. government debt hit their highest levels in five years on Tuesday as anxiety rose over whether the United States will avert a debt default, while selling accelerated in U.S. stocks, particularly among those that have gained sharply of late.
With the partial U.S. government shutdown in its second week and only nine days left for Congress to act before an Oct. 17 U.S. debt ceiling deadline, markets were showing increasing signs of anxiety. President Barack Obama said he would accept a short-term increase to avoid a default but negotiations have not proceeded much from there.
Yields on short-dated bills maturing in the next few weeks rose sharply, and the Treasury sold $30 billion in four-week bills at 0.35 percent, the highest yield since October 2008. Demand was at its weakest in four-and-a-half years, as investors have become concerned about the potential for a missed payment if the Treasury's borrowing authority is not extended with an increase in the debt limit.
"This is the canary in the coal mine," said Eric Green, global head of rates, currency and commodity research at TD Securities in New York. "You could see this seep into other markets. The next shoe to drop is for stocks to drop further. That's why you want the safety of gold and longer-dated Treasuries."
For its three-year auction, the Treasury sold $30 billion at 0.71 percent, indicating more demand for longer-dated issues.
The one-month T-bill rate rose above the one-month London interbank offered rate, or LIBOR, for the first time at least 12 years, according to Reuters data.
One-month yields were at 0.36 percent, nearing the same yield as two-year notes, which yielded 0.37 percent. A survey from J.P. Morgan Securities released on Tuesday showed investors continued to raise their holdings of longer-dated Treasuries, in lieu of short-dated bills.
On Wall Street, selling accelerated as investors bailed out of high-flying stocks, including a number of social media names, that outperformed even as the broader market came under some pressure on worries about the ongoing political back-and-forth in Washington.
The Dow Jones industrial average was down 98.64 points, or 0.66 percent, at 14,837.60. The Standard & Poor's 500 Index was down 14.03 points, or 0.84 percent, at 1,662.09. The Nasdaq Composite Index was down 61.85 points, or 1.64 percent, at 3,708.53.
Global stocks as indicated by the 45-country MSCI world equity index were off 0.6 percent.
As the partial U.S. government shutdown enters a second week, many investors still believe Republicans and Democrats can reach deals on the budget and the debt ceiling.
The broad S&P 500 has declined by only about 3 percent from all-time highs reached in September, as many investors expect a rally once the budget and debt ceiling fights are resolved.
But worries they may fail were beginning to grow. The CBOE Volatility Index, a measure of Wall Street's anxiety, rose to 20.34, up from Monday's 19.41 and the first time that index has hit 20 since June, a sign of rising concern. Technology stocks were the worst performers of the day, with the S&P information technology index down 1.3 percent.
"In our opinion markets are a little too complacent. The downside risks are horrendous if there is no resolution and the debt ceiling is breached," said Kevin Corrigan, head of credit at Lombard Odier Investment Managers.
European equities ended down for a second straight session. The broad FTSE Eurofirst 300 index dipped 0.8 percent.
The dollar fell against the perceived safety of the yen to trade at around 97 yen. It had dropped earlier to 96.55 yen, its lowest since Aug. 12.
The dollar index, which measures the U.S. currency's value against a basket of currencies,, was flat and within striking distance of last week's eight-month low of 79.627. Traders said it remained vulnerable to further selling.
The longer the political deadlock runs, the greater the expected economic damage and the more likely it becomes that the Federal Reserve will maintain its stimulus program, which has flooded global markets with dollars.
The biggest U.S. creditors, China and Japan, have said they are increasingly worried that the developments in Washington could wreak havoc on their trillions of dollars of investments in U.S. Treasury bonds.
"The risk is to the downside for the dollar as long as we don't have an agreement," said Niels Christensen, currency strategist at Nordea.
Banks and investors outside the United States were moving to ensure a steady supply of dollars to cover the critical mid-October period when the government hits the borrowing limit, paying sharply higher premiums in the forward foreign exchange market.
Gold prices were little changed at around $1,323 an ounce as buyers in China, the second-largest market for bullion after India, returned from a week-long holiday.
Benchmark Brent crude oil traded above $110 a barrel, although the gains were expected to be short-lived given an improved supply outlook and fallout from the U.S. budget crisis. U.S. crude was up 81 cents at $103.84.
(Additional reporting by Richard Leong, Julia Edwards, Richard Hubbard, Sudip Kar-Gupta and Jessica Mortimer; Editing by Dan Grebler)