* Nonfarm payrolls up by 173,000 vs 220,000 expected
* Unemployment rate falls to 5.1 pct from 5.3 pct
* Caterpillar falls after broker downgrade
* Indexes down: Dow 1.84 pct, S&P 1.73 pct, Nasdaq 1.29 pct (Updates to early afternoon)
By Tanya Agrawal
Sept 4 (Reuters) - U.S. stocks were down in afternoon trading on Friday as a mixed August jobs report did little to quell investor uncertainty over whether the Federal Reserve will increase rates by mid-September.
Nonfarm payrolls increased 173,000 last month, compared with an upwardly revised 245,000 in July and fewer than the 220,000 that economists polled by Reuters had expected.
But unemployment rate dropped to 5.1 percent, its lowest in more than seven years, and wages accelerated.
"With this jobs report, in which below-expectation job creation in August is offset by several factors - including a lower unemployment rate, prior positive revisions, wage growth, etc - 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.
The Fed, which meets on Sept. 16-17, has said it will increase rates only if it sees sustained economic recovery. While the labor market continues to gain strength, inflation stubbornly remains below the central bank's 2 percent target.
Near-zero rates have allowed the U.S. stock market to stage a spectacular bull-run since the financial crisis. Higher interest rates increase the cost of borrowing and impact the profit margins of companies.
At 13:11 ET (1711 GMT) the Dow Jones industrial average was down 301.21 points, or 1.84 percent, at 16,073.55, with all 30 of its components in the red.
The S&P 500 was down 33.74 points, or 1.73 percent, at 1,917.39 and the Nasdaq composite was down 61.11 points, or 1.29 percent, at 4,672.39.
Apple's was the biggest drag on the S&P and the Nasdaq with a 1.5 percent fall.
All the 10 major S&P sectors were lower with the financial index's 2.05 percent loss leading the decliners. Wells Fargo, JPMorgan and Bank of America fell about 2.5 percent.
Providing further evidence of the nervousness in the market, the CBOE Volatility index, known as Wall Street's "fear gauge", jumped 10.2 percent to 28.22, well above its long-term average of 20. The index spiked to as much as 53.29 last week.
"Investors don't want to take big bets before going into the long weekend, China has been closed for two days and the jobs report just adds to the uncertainty on what the Fed is going to do," said Art Hogan, chief market strategist at Wunderlich Securities.
The recent market turmoil, which left the S&P 500 with its biggest monthly drop in three years in August, has prompted some investors to bet the Fed might wait until the end of the year.
But Fed Vice Chairman Stanley Fischer said last Friday it was still too early to decide if the volatility had made a September hike unfeasible.
Caterpillar's shares were down 1.6 percent at 73.24 after Baird downgraded the stock to "neutral".
Netflix was down 2.5 percent at $98.50. The stock is on track to record 6 straight days of losses for only the second time in more than a year.
Declining issues outnumbered advancing ones on the NYSE by 2,380 to 569. On the Nasdaq, 1,843 issues fell and 824 advanced.
The S&P 500 index showed no new 52-week highs and 12 new lows, while the Nasdaq recorded eight new highs and 52 new lows. (Reporting by Tanya Agrawal in Bengaluru; Additional reporting by Alexandre Boksenbaum in Paris; Editing by Savio D'Souza and Saumyadeb Chakrabarty)