By Sinéad Carew and Nell Mackenzie
NEW YORK/LONDON (Reuters) -MSCI's global equities gauge fell more than 1% on Friday and U.S. Treasury yields dropped as investors worried about the health of the economy after a mixed U.S. jobs report cemented expectations for the Federal Reserve to lower interest rates this month, but created uncertainty about the size of the cut.
The Labor Department reported that U.S. employment increased less than expected in August while the jobless rate dropped in line with expectations to 4.2% from 4.3% in July, suggesting an orderly slowdown in the labor market.
Nonfarm payrolls rose by 142,000 in August but fell short of the 160,000 growth economists polled by Reuters had expected while July numbers were revised down to 89,000 from 114,000.
"The headline number of 142,000 would ordinarily be considered healthy, but this labor market is held together by duct tape and string," said Brian Jacobsen, chief economist at Annex Wealth Management, Menomonee Falls, Wisconsin.
By Friday afternoon, traders were betting on a 73% probability the Fed would cut rates by 25 basis points this month versus 60% on Thursday, while bets for a 50 basis point cut fell to 27% from 40%, CME Group's (NASDAQ:CME) FedWatch tool showed.
Fed officials signaled they would start rate cuts at their meeting in two weeks, noting that a labor market cooling could accelerate into something more dire without a policy shift. The remarks were widely seen as endorsing a 25 basis point cut while leaving the door open to further and perhaps bigger moves should the job market keep slowing.
"Could the Fed cut by 50 bps? Yes, but will they? No. They probably want to start with 25 and retain the option to increase that to 50 rather than just jump right into a 50,” said Jacobsen at Annex Wealth Management.
Wall Street indexes closed sharply lower. They opened higher as investors digested the jobs report and then declined steadily as the day wore on.
The Dow Jones Industrial Average fell 410.34 points, or 1.01%, to 40,345.41, the S&P 500 lost 94.99 points, or 1.73%, to 5,408.42 and the Nasdaq Composite lost 436.83 points, or 2.55%, to 16,690.83.
MSCI's gauge of stocks across the globe fell 10.79 points, or 1.33%, to 801.88. For the week, the index was showing a 3.9% decline, which would be its deepest since the week beginning July 29.
Earlier, Europe's STOXX 600 index closed down 1.1%.
Germany's DAX index had closed down 1.5% earlier after data showed the country's industrial production fell 2.4% in July, compared with analyst expectations for a 0.3% drop.
In the bond market, benchmark 10-year Treasury yields were lower after the payrolls report but managed to back away from a 15-month low hit earlier in the day.
"The market's really struggling with this one because it's really in the middle of what could be used as a justification for either a 25 or 50 basis point rate cut," said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities.
The yield on benchmark U.S. 10-year notes fell 1.2 basis points to 3.721%, from 3.733% late on Thursday.
The 2-year note yield, which typically moves in step with interest rate expectations, fell 8.9 basis points to 3.6627%, from 3.752% late on Thursday.
A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes, seen as an indicator of economic expectations, was at a positive 5.8 basis points.
In currencies, the dollar index rose in volatile trading with focus on the steady slowdown in the labor market suggesting more rate cuts after September.
"A half-point rate cut at the central bank's September meeting remains unlikely, but today's release provided clear evidence of a sharp deterioration in labor market fundamentals, and will bolster bets on at least one jumbo-sized rate cut in the coming months," said Karl Schamotta, chief market strategist at payments company Corpay in Toronto.
The dollar index, which measures the greenback against a basket of currencies including the yen and the euro, gained 0.14% to 101.18.
The euro was down 0.21% at $1.1087. Against the Japanese yen, the dollar weakened 0.76% to 142.35.
In energy markets, oil prices sold off more than 2% in their fifth straight day of declines as concerns around the weak U.S. jobs number outweighed price support from a delay to supply increases by OPEC+ producers.
U.S. crude futures settled down 2.14% at $67.67 a barrel, at their lowest close since June 2023 while Brent ended the session at $71.06 per barrel, down 2.24%, for its lowest close since December 2021.
In precious metals, gold prices sank from near-record levels earlier in the day. Spot gold lost 0.81% to $2,495.86 an ounce. U.S. gold futures fell 1.1% to $2,483.70 an ounce.