Updates to afternoon trading

By Ragini Mathur and Utkarsh Hathi

May 15 (Reuters) - Wall Street's main indexes pulled back sharply on Friday, as inflation fears triggered by the Middle East conflict drove up Treasury yields and threatened to derail an AI-fueled rally that had driven stocks to record highs.

The yield on 10-year Treasury notes US10YT=RR, a benchmark for global borrowing costs, hit 4.58% - its highest level since May 2025. US/

Global bond yields also jumped as increasing evidence of economic damage from the Iran war prompted investors to assume interest rates will rise faster than expected and growth will suffer.

The odds of the U.S. Federal Reserve hiking interest rates by 25 basis points in December have more than doubled over the past week to about 40%, according to CME Group's FedWatch tool, after hotter-than-expected inflation readings signaled price pressures may prove harder to contain.

"Investors are repricing oil higher for longer and factoring in a more persistent inflation backdrop," said Tom Ross, Head of High Yield at Janus Henderson Investors.

"The other, less talked about factor we believe the market is starting to get its head around is the impact of AI... the short-term impact of the huge wave of data center rollout is inflationary."

Brent crude prices LCOc1 rose over 3% to $109.59 a barrel after comments from U.S. President Donald Trump and Iran's foreign minister dented hopes of a quick end to the 2-1/2-month-old conflict in the Middle East. O/R

At 12:08 p.m. ET, the Dow Jones Industrial Average .DJI fell 519.39 points, or 1.04%, to 49,544.07, the S&P 500 .SPX lost 79.60 points, or 1.06%, to 7,421.64 and the Nasdaq Composite .IXIC lost 360.56 points, or 1.35%, to 26,274.66.

The energy sector .SPNY was the lone gainer, rising 1.4%, while all other sectors traded lower, led by losses in technology .SPLRCT.

Recently strong chip stocks came under pressure with Nvidia NVDA.O and AMD AMD.O each falling more than 3%, while Intel INTC.O dropped 6.5%, and the Philadelphia SE Semiconductor Index .SOX slid 3.5%.

The pullback followed another record-setting session on Wall Street on Thursday, when investors had largely brushed aside inflation worries and pushed stocks higher on continued enthusiasm around artificial intelligence.

But Friday's selloff sharply pared those gains, leaving the Dow on track for a weekly loss, while the S&P 500 and the Nasdaq were poised for only marginal weekly advances.

The software sector .SPLRCIS, which has suffered amid continued AI fervor this year, gained 2%.

Investors were also disappointed by the U.S.-China summit, which wrapped up on Friday without a major breakthrough. Talks between the two countries covered a broad agenda including trade, tariffs, Iran and Taiwan.

Among major movers, Microsoft MSFT.O added 3.6%. Bill Ackman's hedge fund Pershing Square will disclose a new position in the company later on Friday, the billionaire investor said.

Dexcom DXCM.O jumped 6.7%. The medical device maker said it will appoint two independent directors and revamp a key board committee in collaboration with activist investor Elliott Investment Management.

Declining issues outnumbered advancers by a 4.39-to-1 ratio on the NYSE, and by a 3.44-to-1 ratio on the Nasdaq.

The S&P 500 posted 12 new 52-week highs and 26 new lows while the Nasdaq Composite recorded 41 new highs and 119 new lows.