US STOCKS-Wall St retreats on debt ceiling jitters

(Updates to midafternoon, changes byline)

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Foot Locker slumps after FY forecast cut, weighs on Nike

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Morgan Stanley slips as CEO plans to step down

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Dow down 0.43%, S&P 500 down 0.33%, Nasdaq down 0.45%

By Chuck Mikolajczak

NEW YORK, May 19 (Reuters) - U.S. stocks fell modestly on Friday as early gains evaporated after U.S. debt ceiling negotiations in Washington were paused, denting optimism a deal could be reached soon to sidestep a default.

Stocks had rallied over the past two sessions on growing confidence a deal to raise the $31.4 trillion debt limit could be reached in coming days, with the benchmark S&P 500 climbing more than 2%. But an initial advance on Friday reversed on reports of the pause in talks while Federal Reserve Chair Jerome Powell spoke at a monetary policy panel.

"I don't think we should be surprised at anything that comes out of Washington commentary-wise," said Frank Cappelleri, founder at CappThesis in New York.

"It doesn't seem like they are treating it as a serious threat only because you are coming off two really strong days so you could make a case that today could have been a down day no matter what came out, what kind of information. The market is looking at it as maybe a reason to give some of the gains back a little bit just because so many areas had gotten extended short-term."

The Dow Jones Industrial Average fell 144.55 points, or 0.43%, to 33,391.36; the S&P 500 lost 13.86 points, or 0.33%, at 4,184.19; and the Nasdaq Composite dropped 57.19 points, or 0.45%, to 12,631.65.

The S&P 500 and Nasdaq were poised for their biggest weekly percentage gains since the final week of March.

The interest rate outlook remained uncertain. Powell said it is still unclear if additional rate increases are needed as the central bank weighs the impact of past hikes as evidenced by the recent troubles in the banking sector.

Also dampening sentiment was a CNN report that U.S. Treasury Secretary Janet Yellen told bank CEOs on Thursday that more bank mergers may be necessary after a series of bank failures.

Shares of regional banks, which were the first in the industry to feel the impact of the Fed's tightening policy, fell, with the KBW Regional Banking index down 2.78%. Still, the index was up nearly 6% on the week and on track to snap a three-week streak of declines as investors viewed the troubles in the sector as largely contained for now.

Shares of Morgan Stanley lost 2.34% after CEO James Gorman announced he would step down from the role in the next 12 months.

Foot Locker Inc plummeted 27.38% and was poised for its biggest daily percentage drop since Feb 25, 2022 after the footwear retailer cut its annual sales and profit forecasts.

The warning weighed on Dow component Nike Inc, which lost 4.11%, while Under Armour Inc fell 4.53%.

Foot Locker's update wraps up a week of caution from other retailers this week, including Target Corp, Home Depot Inc and TJX Companies Inc, as consumer adjust to stubbornly high inflation and a higher interest rate environment.

Declining issues outnumbered advancers on the NYSE by a 1.55-to-1 ratio; on Nasdaq, a 1.24-to-1 ratio favored decliners.

The S&P 500 posted 28 new 52-week highs and three new lows; the Nasdaq Composite recorded 72 new highs and 69 new lows. (Reporting by Chuck Mikolajczak; Editing by Richard Chang)