US STOCKS-Wall St drops as jobs data leaves Fed-watchers hanging

* Jobs data transmits mixed message to Fed watchers

* Caterpillar (NYSE: CAT - news) falls after broker downgrade

* Microsoft (NasdaqGS: MSFT - news) drags down S&P 500

* Indexes down: Dow 1.97 pct, S&P 1.85 pct, Nasdaq 1.42 pct (Adds detail on jobs data, comment, updates prices )

By Noel Randewich

Sept 4 (Reuters) - U.S (Other OTC: UBGXF - news) . stock indexes dropped almost 2 percent on Friday as a mixed August jobs report did little to quell investor uncertainty about whether the Federal Reserve will increase interest rates this month.

Trepidation about the first U.S. rate hike in almost a decade added to worries among investors already on edge about a stumbling Chinese economy and a recent market selloff.

"Markets are confused. It (Other OTC: ITGL - news) was an okay jobs report, but there's worry about China going into the weekend," said John Augustine, chief investment officer, Huntington Trust in Columbus (Copenhagen: COLUM.CO - news) , Ohio.

Nonfarm payrolls increased 173,000 last month, fewer than the 220,000 that economists polled by Reuters had expected. But the unemployment rate dropped to 5.1 percent, its lowest in more than seven years, and wages accelerated. Many investors viewed those data points as contradictory signals about the urgency to increase interest rates.

"The Federal Reserve finds itself in a real uncertainty jam when it comes to a September interest rate hike," said Mohamed El-Erian, chief economic adviser at Allianz.

Near-zero rates have allowed the U.S. stock market to stage a spectacular bull-run since the financial crisis. Many on Wall Street hope recent global market turmoil and worries about China's economy will lead the Fed to hold off raising rates when it meets on Sept. 16-17.

Following Friday's employment data, futures market traders predicted about a 20 percent chance a rate hike change will come this month, down from around 30 percent before the jobs report and from a more than 50 percent probability before world markets started tumbling two weeks ago.

At 2:02 pm, the Dow Jones industrial average was down 1.97 percent at 16,052.4 and the S&P 500 lost 1.85 percent to 1,915.04 points.

The Nasdaq Composite dropped 1.42 percent to 4,666.48.

Microsoft was the biggest drag on the S&P and the Nasdaq with a 2.67 percent fall.

All the 10 major S&P sectors were lower with the financial index's 2.26 percent loss leading the decliners. Wells Fargo, JPMorgan (LSE: JPIU.L - news) and Bank of America (Swiss: BAC.SW - news) fell more than 2.25 percent.

The CBOE Volatility index, known as Wall Street's "fear gauge", jumped 13 percent to 28.99, well above its long-term average of 20.

Caterpillar's shares were down 1.5 percent after Baird downgraded the stock to "neutral".

Netflix (Xetra: 552484 - news) lost 3.08 percent and was on track to record 6 straight days of losses.

Declining issues outnumbered advancing ones on the NYSE by 2,386 to 582. On the Nasdaq, 1,889 issues fell and 815 advanced.

The S&P 500 index showed no new 52-week highs and 15 new lows, while the Nasdaq recorded eight new highs and 56 new lows. (Additional reporting by Tanya Agrawal in Bengaluru, Sinead Carew in New York and Alexandre Boksenbaum in Paris; editing by Saumyadeb Chakrabarty and Andrew Hay)