NEW YORK -- Stocks ground lower Tuesday as budget gridlock in Washington brought the U.S. closer to an unprecedented default on its debt.

After opening relatively flat, the stock market moved steadily lower in late morning trading. Nervous investors dumped short-term government debt as they worried that the standoff in Washington could jeopardize the nation's ability to pay its bills, including interest on its debt, as early as next week if Congress doesn't raise the nation's borrowing limit.

House Republicans have insisted that a temporary funding bill contain concessions on President Barack Obama's health care law. The president wants a bill to simply reopen the government, without strings attached.

Unfortunately, we're just held hostage by what's going on in Washington,'' said Dan Veru, Chief Investment Officer of Palisade Capital Management. ``The markets are somewhat directionless right now.''

Treasury officials warned last week that the U.S. could plunge into recession if the debt ceiling wasn't raised. Democrats controlling the Senate plan to move quickly toward a vote to allow the government to borrow more money, challenging Republicans to a filibuster.

The S&P 500 index dropped 17 points, or 1 percent, to 1,659 as of 2:15 p.m. (1815 GMT). The index is trading at its lowest level in a month. Declines were led by phone companies.

The Dow Jones industrial average fell 120 points, or 0.8 percent, to 14,815. The Nasdaq composite dropped 67 points, or 1.8 percent, to 3,702.

Concerns about the budget impasse have pushed stocks from record levels reached in September. The declines have been small, but steady. The S&P 500 has dropped on 11 out of the past 14 days and has lost 3.8 percent since closing at an all-time high of 1,725 points on Sept. 18.

U.S. companies will start reporting earnings for the third quarter this week, giving investors something else to think about other than Washington. Aluminum producer Alcoa, which was recently removed from the Dow Jones industrial average, is scheduled to report its earnings after the close of trading Tuesday. JPMorgan and Wells Fargo are also among the companies releasing earnings this week.

There were signs in the bond market and elsewhere that investors are getting increasingly uncomfortable with the stand-off in Washington.

In government debt trading, the yield on Treasury bills maturing in one month soared to 0.28 percent, hitting its highest yield since the 2008 financial crisis. The yield was 0.15 percent on Monday and close to zero at the beginning of October.

The yield, which rises as the price of the notes fall, has surged as managers of money-market funds become more wary of holding short-term government debt that matures shortly after the debt deadline.

The yield on the 10-year Treasury note was little changed at 2.63 percent. The yield on the longer-term note has fallen in the past month, suggesting that investors see any potential default as a short-term phenomenon and are predicting that economic growth will remain subdued in the longer term.

The VIX index, which rises when investors are getting more concerned about stock fluctuations, rose again and is close to its highest level of the year.

Stocks also slumped the last time that the U.S. came close to hitting its debt ceiling in the summer of 2011. The S&P 500 dipped 5 percent between the start of July and Aug. 2 of that year, when President Barack Obama signed into a law a bill that raised the debt ceiling and promised more than $2 trillion in cuts to government spending over a decade. Stocks extended their slide after S&P cut its rating on U.S. government debt on Aug. 5.

Analysts point out, though, that the global economy was in a far more fragile state two years ago than it is now. Europe was still in the throes of its debt crisis, the U.S. economic recovery was less entrenched and the U.S. budget deficit has shrunk since then.

The dollar fell against the euro and rose against the Japanese yen.

In commodities trading, the price of oil rose 60 cents, or 0.7 percent, to $103.79 a barrel. Gold fell $1.20 to $1,323 an ounce.

Among stocks making big moves:

_ Jamba plunged $2.44, or 18.1 percent, to $11.03 after the fruit smoothie company cut its fiscal 2013 guidance, saying reduced spending by consumers hurt its sales in the third quarter.

_ Xerox fell 26 cents, or 2.4 percent, to $10.15 after the company said the Securities and Exchange Commission is investigating accounting practices at one of its units.

_ McKesson rose $4.59, or 3.5 percent, to $134.10 after The Wall Street Journal reported that the health services company was in talks to acquire its German rival Celesio for about $5.1 billion.

_ J.C. Penney gained 25 cents, or 3.2 percent, to $7.96, after the company reported encouraging sales trends for September. The struggling department store owner, which has faced concerns it is burning through cash, still anticipates having ample liquidity at year's end. (AP)