* Auctions for 3-month and 6-month bills is tepid
* One-month T-bill rates volatile on debt ceiling worries
* U.S. Treasury pays higher costs on short-term debt
By Richard Leong
NEW YORK, Oct 7 (Reuters) - The sale of $65 billion of U.S. Treasury bills on Monday met some of the weakest demand in more than three years as investors grow more fretful about a possible default on the federal debt as Washington's budget standoff drags on with no end in sight.
Investors shied away from sales of $35 billion of 3-month bills and $30 billion of 6-month paper, with a key measure of demand for the shorter maturity, the so-called bid-to-cover ratio, at 3.88, the lowest since April 2010. Demand for the 6-month bills was marginally stronger, but at just 4.40 the bid-to-cover was still the lowest since April 2012.
As a result, total government borrowing costs for the two issues rose by more than $5 million from comparable sales a week ago, with interest rates on both the highest in six weeks. They also illustrate a tangible cost of the budget standoff that has partially closed the federal government since Oct. 1.
The Treasury Department has estimated it will reach the cap on its $16.7 trillion of borrowing authority around Oct. 17 unless the White House and Republican lawmakers strike a deal to raise the limit. Estimates on when the government will actually run out of the funds on hand to pay its bills range from one to two weeks after that date.
"Bill rates have been volatile lately due to the debt ceiling issue. The very front-end has been illiquid with investors staying away," said Tom Simons, money market strategists at Jefferies & Co in New York.
Moreover, Monday's auctions augur poorly for a closely watched sale of $30 billion of 1-month bills scheduled for Tuesday.
Demand at last week's sale of 4-week U.S. paper, in normal times considered the safest of investments that would draw healthy demand from institutional investors such as money market funds, was especially poor. That is because those bills mature around the time investors estimate the government might finally run out of the cash on hand to pay all of its obligations. The bills being sold on Tuesday will mature Nov. 7.
"With this threat of not being repaid, this might discourage some investors on the margin from investing in the U.S.," said Andrew Milligan, head of global strategy of Standard Life's multi-asset investing team in Edinburgh, Scotland.
Since last week's bill sale, interest rates on 1-month bills have moved sharply higher, rising from near zero less than two weeks ago to a closing level on Monday of 0.16 percent, the highest end-of-day reading since Nov. 28, 2012.
Their sharp rise has caused a so-called inversion of the T-bill curve, meaning interest rates for some shorter maturities are higher than for longer maturities. Three-month T-bill rates closed at 0.035 percent on Monday, 0.125 percent below the 1-month rate. Typically, rates are higher for longer-dated debt.
In addition to Tuesday morning's $30 billion bill auction, the Treasury will sell $30 billion of three-year debt in the afternoon.
In the "when-issued" market, traders expected the Treasury to pay an interest rate of 0.15 percent for the 1-month bills . This would be the highest interest rate for investors on its one-month debt since November.
On the other hand, traders anticipate the latest three-year notes to clear at a yield of 0.671 percent, below the 0.913 percent yield last month, which was the highest at a three-year auction since May 2011.
More auctions for longer-dated Treasuries are scheduled later in the week as well. The Treasury will sell $21 billion in 10-year notes on Wednesday and $13 billion in 30-year bonds on Thursday.