By David Morgan

WASHINGTON U.S. House Speaker Kevin McCarthy is facing the biggest challenge of his eight months as the top Republican in the U.S. Congress, as he tries to muster his fractured caucus to avoid a government shutdown in less than two weeks without losing his speakership.

The Republican-controlled House of Representatives and the Democratic-led Senate have until Sept. 30 to avoid the U.S.' fourth partial government shutdown in a decade by passing spending legislation that President Joe Biden can sign into law to keep federal agencies afloat.

But hardline activism on spending, policy and impeachment have split Republicans in the House and slowed the Senate's path forward on approving bipartisan spending legislation.

Political brinkmanship has begun to attract the attention of Wall Street, with rating agency Fitch citing repeated down-to-the-wire negotiations that threaten the government's ability to pay its bills when it downgraded U.S. debt rating to AA+ from its top-notch AAA designation earlier this year.

House Democratic leader Hakeem Jeffries warned on Sunday that the situation amounts to a Republican "civil war." The log-jams are not limited to the House, as one hardline Senate Republican holdout, Tommy Tuberville, has blocked confirmation of hundreds of senior military officers in a dispute over abortion access.

McCarthy said he hopes to move forward this week on an $886 billion fiscal 2024 defense appropriations bill, which stalled last week as hardliners withheld support to demand a top line fiscal 2024 spending level of $1.47 trillion - $120 billion less than what McCarthy and Biden agreed to in May.

"I gave them an opportunity this weekend to try to work through this," the California Republican said in a Sunday interview with the Fox News "Sunday Morning Futures" program.

He said weekend negotiations with hardliners had made progress, but added: "We'll bring it to the floor, win or lose, and show the American public who's for the Department of Defense, who's for our military."

Late on Sunday, hardline and moderate House Republicans reached agreement on a short-term stopgap spending bill, known as a "continuing resolution" or CR, that could help McCarthy move forward on the defense legislation.

The measure would keep federal agencies afloat until Oct 31, giving Congress more time to enact full-scale appropriations for 2024. However, it was not clear whether it would garner enough Republican support to pass the House.

But like the defense bill, which the White House has already threatened to veto, the CR is unlikely to succeed with Democrats and become law.

It would impose a spending cut of more than 8% on agencies other than the Defense Department and Department of Veterans Affairs and it includes immigration and border security restrictions that Democrats reject.

With a 221-212 majority, McCarthy himself can afford to lose no more than four votes to pass legislation that Democrats unite in opposing.

He declared last week that "nobody wins" in a shutdown and pledged to keep the House in session through next weekend if necessary until legislation to fund the government is in place.

But some members of the hardline House Freedom Caucus are openly embracing a shutdown as a negotiating tactic to get their way on spending and conservative policy priorities.

"We have to hold the line," Representative Chip Roy, a Freedom Caucus member, said late last week. He told a cheering conservative audience that a shutdown is now "almost" inevitable and said conservatives must be prepared for "the fight coming in October."

Moderate Republicans predict that Congress will ultimately adhere to the spending level set by the Biden-McCarthy agreement.

"At the end of the day, that's the only thing that's going to be enacted into law," said Representative Patrick McHenry, a close adviser to McCarthy.

Unless the House can move forward on spending, Republican leaders say privately that they could be forced to move directly into negotiations with Senate Democrats on appropriations bills, circumventing hardliners.

The goal would be bipartisan legislation that could pass both chambers quickly and be signed into law by Biden. But the consequences could be dire for McCarthy, who is already staring down the threat of ouster.

"It'd be the end of his speakership," said Representative Ralph Norman, another Freedom Caucus member.

Other House Republicans fear that McCarthy's decision to open an impeachment inquiry of Biden could make it harder to gain cooperation on spending from Democrats. The White House has blasted the probe as unsubstantiated and many moderate Republicans say they have seen no tangible evidence of wrongdoing by the president.

"We are barreling toward a government shutdown without making progress on cutting our out-of-control spending. Yet Republican leadership has decided to divert attention to an impeachment inquiry," Representative Ken Buck said in a Washington Post Op-Ed late last week. "Republicans in the House who are itching for an impeachment are relying on an imagined history."

(Reporting by David Morgan, additional reporting by Richard Cowan; Editing by Scott Malone, Sandra Maler and Shri Navaratnam)