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* China ready to hit back at U.S. with rare earths -newspapers
* Bond yields drop to 20-month lows; Bank stocks fall
* All major S&P sectors fall; energy leads losses
* Capri plunges after profit forecast disappoints
* Indexes down: Dow 1.21%, S&P 0.89%, Nasdaq 0.92% (Updates prices to early afternoon)
By Amy Caren Daniel
May 29 (Reuters) - Wall Street’s main indexes hit a near three-month low on Wednesday, as growing fears of a protracted trade war between the United States and China sent investors scurrying for the safety of government bonds.
Chinese newspapers warned on Wednesday that Beijing could use rare earths to strike back at the United States after President Donald Trump remarked he was “not yet ready” to make a deal with China over trade.
Fueling worries, China’s Huawei Technologies Co Ltd filed a lawsuit against the U.S. government in its latest bid to fight sanctions from Washington.
“The question about what China will do with rare has always been there, it is certainly alarming and ratchets up the level of uncertainty,” said Tom Martin, senior portfolio manager at GlobAlt Investments in Atlanta.
“It’s a flight to safety in the United States. There are fears that are driving investors to Treasuries and you have a market that reached its peak about a month ago.”
The benchmark S&P 500 index is now about 6% away from its all-time high of 2,954.13 hit on May 1.
The uncertainty in markets have pressured investors to dump equities and seek safety in U.S. government debt, which has led to an inversion of the yield curve between three-month bills and 10-year notes, a precursor to a possible recession.
Federal funds futures indicated that traders saw a 62% chance the U.S. central bank would lower policy rates by a quarter at its Sept. 17-18 meeting, compared with a 50% likelihood late on Tuesday.
Interest-rate sensitive banking stocks fell 0.78%, while the broader financial sector was off 0.69%.
Technology stocks fell 0.66% and weighed the most on markets, hit by losses in shares of iPhone maker Apple Inc , Microsoft Corp and chipmakers.
The Philadelphia chip index was down 0.47%.
At 12:49 p.m. ET, the S&P 500 was down 24.89 points, or 0.89%, at 2,777.50 and the Nasdaq Composite was down 69.78 points, or 0.92%, at 7,537.57, their lowest level since March.
The Dow Jones Industrial Average was down 305.83 points, or 1.21%, at 25,041.94, its lowest since February.
The benchmark S&P index fell below its 200-day moving average, a key indicator of long-term momentum during the session.
All the major S&P sectors were in the red, with the energy sector posting the steepest loss of 1.35%, weighed down by weak crude prices.
Energy and technology stocks are the worst-performing S&P sectors this month.
Among other stocks, Johnson & Johnson dropped 5.4% after a lawsuit that accused the drugmaker of fueling the U.S. opioid epidemic proceeded to its second day of trial, pulling healthcare stocks down 1.20%.
Capri Holdings Ltd plunged 11%, the most among S&P companies, after the Michael Kors owner issued a disappointing first-quarter profit forecast as it spends more on marketing.
General Mills dropped 5.9% after Goldman Sachs downgraded the stock to “sell”.
Declining issues outnumbered advancers for a 2.59-to-1 ratio on the NYSE and for a 2.69-to-1 ratio on the Nasdaq.
The S&P index recorded no new 52-week high and 40 new lows, while the Nasdaq recorded 15 new highs and 190 new lows. (Reporting by Amy Caren Daniel and Shreyashi Sanyal in Bengaluru; Editing by Anil D’Silva)