By Karen Brettell

(Reuters) - Money market participants are starting to price in the risk that payments due on U.S. Treasury debt in October may be delayed, as Congress drags out raising the nation’s debt limit three months before the government has said it will run out of money.

Yields on three-month Treasury bills <US3MT=RR>, which are due to mature on Oct. 19, rose to 1.17 percent on Thursday, higher than the 1.12 percent yields paid on six-month debt <US6MT=RR>.

Longer-dated debt normally pays higher returns than shorter-dated bills, with an inversion in the yield curve reflecting that investors are concerned with being repaid in October.


“That suggests that there are mounting concerns over the debt limit,” said Mark Cabana, head of short rates strategy at Bank of America Merrill Lynch in New York.

The Congressional Budget Office said last month that Congress will need to raise the debt limit by early to mid-October to avoid a default.

Investors are concerned about the debt ceiling as Republicans disagree on healthcare legislation, which is distracting from budget negotiations.

Legislators are also due to take recess in August, which will delay activity until they return in early September.

Tepid investor demand for a $39 billion sale of three-month bills this week also reflected concern about October maturities, and left dealers with more of the bills than they had anticipated.

“It may have been the case that certain dealers took down more of the three-month bills than they wanted to and as a result have had to adjust positions,” said Cabana.

While elevated, yields on the three-month bills are not yet reflecting a high risk of default. That may change, however, as October approaches without an increase in the debt ceiling.

When negotiations over raising the debt ceiling came down to the wire in October 2013 investors also pulled cash from the repurchase agreement (repo) market, adding to pressure on bond yields.

“Usually what happens is cash moves out of the repo market because nobody wants to have a bank give them a security that pays a coupon or matures soon," said Scott Skyrm, a managing director at Wedbush Securities in New York. "Investor cash gets scared and comes out of the market, and that pushes rates higher.”

(Reporting by Karen Brettell; Editing by Andrea Ricci)

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