* World shares drop for 3rd day on U.S. deadlock
* Dollar makes gains on yen and Swiss franc on Fed minutes
* Oil dips below $110, gold eases
By Barani Krishnan
NEW YORK, Oct 9 Strains in short-term interest rates and funding markets increased on Wednesday as the battle over the U.S. debt ceiling heats up, 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, stocks edged higher, recovering some of the day's earlier declines, while high-performing technology stocks added to recent losses amid an ongoing Washington standoff and a looming deadline to raise the U.S. debt ceiling.
Short-dated U.S. Treasury bill yields were higher on increased concern 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 to their highest in five months on similar fears.
The Federal Reserve's minutes from its September meeting showed that most members of the 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."
On the release, the U.S. dollar rallied, with the dollar index rising to 80.52, up 0.6 percent, and the euro falling to $1.3489, down 0.6 percent on the day.
At 2:10 ET (1710 GMT), the Dow Jones industrial average was up 66.21 points, or 0.45 percent, at 14,842.74. The Standard & Poor's 500 Index was up 5.65 points, or 0.34 percent, at 1,661.10. The Nasdaq Composite Index was down 6.93 points, or 0.19 percent, at 3,687.90.
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 7/32, its yield at 2.6631 percent.
The expected nomination of Janet Yellen to head the Federal Reserve had a modest effect on markets, meanwhile, given the political wrangling in Washington that could lead a U.S. debt default within the next few weeks.
The 67-year-old Yellen 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, its lowest level since Sept. 9.
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.
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 euro fell 0.4 percent to $1.3515. 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, oil prices eased 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 1.5 percent at $1,306 an ounce, after hitting a 1-week bottom at below $1,300.