* World shares drop for 3rd day on U.S. deadlock
* Yellen nomination as Fed chief provides limited relief
* Dollar makes gains on yen and Swiss franc
* Brent oil dips below $110, gold eases
By Barani Krishnan
NEW YORK, Oct 9 (Reuters) - Strains in short-term interest rates and funding markets rose on Wednesday as the U.S. debt ceiling battle heats up, while the expected nomination of Janet Yellen as Federal Reserve chief boosted the dollar.
Wall Street stocks began the day in positive territory, but quickly gave up gains due to ongoing worry about the government shutdown and the potential for a debt default. The sharpest declines were in technology stocks, particularly in the social media industry and others that have led the market this year.
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 dollar index erased early losses and was up about 0.4 percent at 80.41, edging away from the 79.627 trough hit last Thursday, a low not seen since early February.
The first woman to head the U.S. central bank, the 67-year-old Yellen is seen largely sticking to Bernanke's policies that are aimed at keeping economic recovery on track. A White House official said President Barack Obama would nominate Yellen, who is now deputy Fed chief, later in the day.
"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. "It does remove another hurdle, another piece of the puzzle, another piece of uncertainty that the market likes to see resolved."
While the Yellen nomination had a modest effect on a few markets, the impact was short-lived given the political wrangling in Washington that could lead a U.S. debt default within the next few weeks.
The Dow Jones industrial average rose 12.07 points or 0.08 percent, to 14,788.6, the S&P 500 lost 1.58 points or 0.1 percent, to 1,653.87 and the Nasdaq Composite dropped 25.836 points or 0.7 percent, to 3,668.997.
Long-dated U.S. Treasuries prices dipped as investors awaited minutes from the Fed's September policy meeting, expected to provide clues as to why the central bank decided against paring its monthly $85 billion in bond purchases.
Impending new sales of 10-year and 30-year Treasuries kept U.S. bonds under pressure. The U.S. Treasury will sell $21 billion of 10-year notes at 1 p.m. ET (1700 GMT).
The benchmark 10-year U.S. Treasury note was down 4/32, its yield at 2.6503 percent.
European shares hit a one-month low.
Earlier, the MSCI index of Asia-Pacific shares outside Japan had dipped on the budget deadlock, losing 0.3 percent, and MSCI's world index was down 0.4 percent, its lowest level since Sept. 9.
The main U.S. fear gauge, the CBOE Volatility Index, stood at its highest level since June 20.
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.
"What the market is trying to do is looking through the rhetoric and it appears that both sides behind closed doors might be coming up with some kind of a face-saving deal. That's another reason why the dollar is rallying," said Boris Schlossberg, managing director of FX Strategy at BK Asset Management in New York.
The euro fell 0.4 percent to $1.3512. Against the yen, the dollar rose 0.4 percent to 97.22 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 the commodity markets, oil prices eased below $110 a barrel on concerns that the budget deadlock would weigh on investor confidence, hurting demand for crude.