(Adds comment in paragraphs 4-5, oil settlement prices, updates prices at 3:10 p.m. ET)
NEW YORK/LONDON, Jan 2 (Reuters) - Stocks in Europe and on Wall Street fell on Tuesday, along with prices for U.S. government debt, as market optimism that the Federal Reserve can engineer a soft landing as it cuts interest rates this year lost a bit of luster.
The dollar jumped against major currencies as the yield on the 10-year Treasury note, which moves inversely to price, rebounded to trade above 4% early in the day.
The U.S. benchmark's yield last week traded as low as 3.783%, or more than the 150 basis points of rate cuts the futures have priced in by next December for the Fed's target interest rate as the market weighs the economic outlook.
The biggest concern is whether the market misinterprets slowing growth as a warning sign for a looming recession, said Jack Janasiewicz, portfolio manager and lead portfolio strategist at Natixis Investment Managers Solutions in Boston.
"The risk is that we get a couple of soft prints (but) the one that matters the most is going be the labor market," he said. "My gut says that the market will extrapolate weakness into that hard landing outcome. That's probably going to be somewhat of a misleading backdrop."
Technology shares led stock market declines on both sides of the Atlantic as weaker rate cut optimism amid a slowing economy gnawed at sentiment. The Atlanta Fed's GDPNow estimate for seasonally adjusted annualized growth in the fourth quarter of 2023 fell to 2.0% on Tuesday from 2.3% on Dec. 22.
In addition, U.S. construction spending rose less than expected in November amid a decline in outlays on public projects. However, data for the prior month was revised sharply higher suggesting underlying strength in the sector.
The dollar was firmer because its recent sell-off was overdone, said Marc Chandler, chief market strategist at Bannockburn Global Forex in New York. The jobs report for December this Friday will likely show a still robust U.S. labor market, he said.
"When the Fed meets later this month they're going to see above-trend growth and a resilient labor market. A resilient labor market means income, which means demand, that's why the dollar is recovering," Chandler said.
A Reuters polls shows economists expect 168,000 jobs were created last month, down from 199,000 in November, and the unemployment rate will tick up to 3.8% from 3.7%.
The dollar index, a measure of the U.S. currency against six major trading partners, rose 0.78%. The euro was down 0.87% to $1.0948 and the Japanese yen weakened 0.73% at 141.92 per dollar.
In Europe, the pan-regional STOXX 600 index lost 0.11% while MSCI's gauge of stocks across the globe shed 1.03%.
On Wall Street, the Dow Jones Industrial Average fell 0.24%, the S&P 500 lost 0.95% and the Nasdaq Composite dropped 2.12%.
The three major U.S. stock indexes had notched monthly, quarterly and annual gains last Friday as traders priced in higher chances of rate cuts by the Fed this year. The benchmark S&P 500 ended last week within 1% of a record closing high reached on Jan. 3, 2022.
Futures show traders expect about a 78% chance of a 25 basis point cut or more in the Fed's overnight rate when policymakers meet in March, according to the CME Group's FedWatch Tool. Traders see the Fed's target rate at 3.843% in December .
Traders are trying to affirm whether major central banks will judge inflation has slowed enough to allow for deep rate cuts.
"There is a feeling that (monetary) easing is coming and it seems like there is more to go in the rally in the short term," said Nordea chief analyst Jan von Gerich. "I think there's a risk to the downside for stocks but the momentum is strong right now," he said.
Oil prices jumped more than 2%, in a move analysts said was due to an escalation in tensions in the Red Sea as well as hopes for strong demand from China, where investors are expecting fresh stimulus measures.
U.S. helicopters repelled an attack on Sunday by Iran-backed Houthi militants on a Maersk container vessel in the Red Sea, sinking three Houthi boats and killing 10 militants. Investors are weighing up the risks of the Israel-Gaza war becoming a wider regional conflict, which could close crucial waterways for oil transport.
U.S. crude settled down $1.27 to $70.38 a barrel, while Brent fell $1.15 to settle at $75.89 a barrel.
Separately, the head of energy firm E.ON said instability in the Middle East could send energy prices soaring, but that Germany's gas supply is in far better shape than it was after Russia cut off supplies last winter.
Data pointing to subdued business confidence in China for 2024 weighed on Chinese assets during Asian trading. China's onshore blue chip index was down 1.3% and Hong Kong's Hang Seng index fell 1.5%.
The yield on the 10-year Treasury note rose 8.3 basis points to 3.943%.
Euro zone government bond yields rose, with the benchmark 10-year German yield up 2.8 basis points on the day at 2.057%.
Spot gold dropped 0.1% to $2,061.07 an ounce.
(Reporting by Herbert Lash; Additional reporting by Elizabeth Howcroft and Dhara Ranasinghe in London; Editing by Nick Macfie and Nick Zieminski)
