Wall Street tumbles after N.Korea test, rate hike worry

By Chuck Mikolajczak

NEW YORK (Reuters) - U.S. stocks dropped on Friday as investors were unnerved by a nuclear test by North Korea and comments by a U.S. Federal Reserve official that pointed towards an interest rate hike.

North Korea conducted its fifth and biggest nuclear test on Friday and said it had mastered the ability to mount a warhead on a ballistic missile, drawing condemnation from the United States as well as China, Pyongyang's main ally.

There was further pressure on the equity market after Boston Fed President Eric Rosengren, a historically dovish policymaker, said the Federal Reserve increasingly faced risks if it waited too much longer. He said a gradual policy tightening was likely appropriate, although he added the central bank was unlikely to raise rates too rapidly.

"Certainly the posturing of the Fed is creating a lot of noise, and when you get comments like that, it creates a little bit of anxiety in the market," said Phil Blancato, chief executive of Ladenberg Thalmann Asset Management in New York.

But Fed Governor Daniel Tarullo, also a voting member, was more cautious and said on Friday in an interview with CNBC that he wanted to see more evidence of U.S. inflation rising back toward the central bank's 2 percent target, although he would not discount the possibility of a hike this year.

The Dow Jones industrial average fell 194.77 points, or 1.05 percent, to 18,285.14, the S&P 500 lost 26.65 points, or 1.22 percent, to 2,154.65 and the Nasdaq Composite dropped 59.40 points, or 1.13 percent, to 5,200.09.

The Fed will hold a two-day policy meeting on Sept. 20-21. Expectations for a September rate hike climbed to 27 percent in the wake of the Fed comments, according to CME's FedWatch tool, up from 18 percent the previous day.

Utilities and telecoms were down 2.3 percent and 1.8 percent, respectively, and were among the worst performing of the 10 major S&P sectors. The sectors have been strong performers on the year as their high dividends have been used by investors as a bond proxy.

U.S. stocks have been subdued for two months, with the benchmark S&P 500 index failing to register a move of more than 1 percent on a closing basis in either direction since July 8. The index is currently on track for its worst day since June 27.

U.S. wholesale inventories were unchanged in July as previously reported and sales fell, suggesting a limited boost to economic growth from restocking in the third quarter.

Energy shares, down 1.8 percent, also slumped as Brent and U.S. crude fell nearly 3 percent after surging more than 4 percent in the prior session. Exxon Mobil, off 1.6 percent to $87.64, was the biggest drag on the S&P 500.

(Reporting by Chuck Mikolajczak; Editing by Bernadette Baum and Nick Zieminski)