By Johann M Cherian, Sukriti Gupta and Carolina Mandl
(Reuters) -U.S. stocks sold off on Friday, with the S&P 500 erasing its 2025 gains, after an upbeat jobs report stoked fresh inflation fears, reinforcing bets that the Federal Reserve will be cautious in cutting interest rates this year.
Wall Street's main indexes closed their second consecutive week in the red.
"We started the year on the wrong foot," said Sam Stovall, market strategist at CFRA Research, commenting on the impact of a hotter-than-expected job data on equities. He added the environment for stocks could become "quite challenging."
The Dow Jones Industrial Average fell 696.75 points, or 1.63%, to 41,938.45, the S&P 500 lost 91.21 points, or 1.54%, to 5,827.04 and the Nasdaq Composite lost 317.25 points, or 1.63%, to 19,161.63.
The domestically focused small-cap Russell 2000 index also fell 2.27%, slipping into correction territory as it was down 10.4% from its Nov. 25 closing high. Wall Street's fear gauge hit a three-week high on Friday.
A Labor Department report showed job growth unexpectedly accelerated in December while the unemployment rate fell to 4.1% as the labor market ended the year on a strong note.
A hotter-than-expected job gain could translate into faster economic expansion, leading to a rise in prices. To contain a still-elevated inflation, the Fed could be forced to take a more conservative stance on rate cuts this year.
Traders see the central bank lowering borrowing costs for the first time in June and then staying steady for the rest of the year, according to the CME Group's (NASDAQ:CME) FedWatch Tool.
Brokerages also revised their Fed rate cut forecasts, with BofA Global Research forecasting a potential rate hike.
However, Chicago Fed president Austan Goolsbee said there is no evidence the economy is overheating again, adding he still expects it will be appropriate to lower interest rates further.
Pressuring stocks, the yield on the 30-year Treasury note touched 5% - its highest since November 2023, but slightly retreated to 4.966%.
Most of the 11 S&P 500 sectors declined, except for the energy index, which rose 0.34%.
Adding to the dour mood, a University of Michigan survey showed consumer sentiment dropped to 73.2 in January from the previous month.
Fresh inflation worries have taken the spotlight, compelling the Fed to issue a cautious forecast on monetary easing last month, as it anticipates policy changes on trade and immigration under President-elect Donald Trump, who is expected to take office in 10 days' time.
On Jan. 15, investors will closely watch the release of the monthly consumer price index, which could spark further volatility if it comes in higher than expectations.
"Markets would sell off meaningfully because all of a sudden the Fed is probably in a position not just to not cut rates and support markets, but to actually hike rates," said Bryant VanCronkhite, senior portfolio manager at Allspring.
Chip stocks such as Nvidia dropped roughly 3%, weighed down by a report that the U.S. could announce new export regulations as early as Friday.
Constellation Energy (NASDAQ:CEG) soared 25.16% after agreeing to buy privately held natural gas and geothermal company Calpine Corp for $16.4 billion, while Constellation Brands (NYSE:STZ) slid 17.09% after cutting its annual sales and profit forecasts.
Walgreens Boots Alliance (NASDAQ:WBA) jumped 27.55% after reporting an upbeat quarterly profit.
Declining issues outnumbered advancers by a 4.24-to-1 ratio on the NYSE and by a 3.32-to-1 ratio on the Nasdaq.
The S&P 500 posted 6 new 52-week highs and 32 new lows while the Nasdaq Composite recorded 39 new highs and 211 new lows.
Volume on U.S. exchanges was 16.24 billion shares, compared with the 12.31 billion average for the full session over the last 20 trading days.