(For a live blog on the U.S. stock market, click or type LIVE/ in a news window)
* U.S. air strike in Iraq kills head of Iran's Quds Force
* Manufacturing sector contraction sparks slowdown fears in U.S.
* Bank stocks fall as bond yields slide
* Energy stocks, gold miners track higher commodity prices
* Indexes down: Dow 0.60%, S&P 0.43%, Nasdaq 0.37% (Updates prices)
By Manas Mishra and Medha Singh
Jan 3 (Reuters) - Wall Street fell from a record high on Friday after a U.S. air strike in Iraq ratcheted up tensions in the Middle East, while a bigger-than-expected contraction in the U.S. manufacturing sector again fanned fears of slowing economic growth.
Demand for safe-haven assets soared as Iran vowed revenge for the killing of Qassem Soleimani, head of its elite Quds Force, in an air strike authorized by President Donald Trump.
The banks sub-sector dropped about 1% as the news sent benchmark U.S. bond yields to their lowest since Dec. 12. Eight of the 11 S&P 500 sectors were in the red, with only sectors considered defensive plays, such as real estate, trading higher.
"The sharp escalation in tensions related to the Middle East is certainly driving the trading narrative for U.S. stocks," said Peter Kenny, founder of Kenny's Commentary LLC in New York.
"Does it mean continued escalation in tension (and) will it end up derailing the U.S. equity rally? I don't think so, but it's worth considering."
The three main stock indexes had closed at record highs on Thursday, as fresh monetary stimulus by China added to investor optimism over trade.
However, denting sentiment on Friday, data showed the U.S. manufacturing sector contracted in December by the most in more than a decade.
At 12:43 p.m. ET, the Dow Jones Industrial Average was down 173.13 points, or 0.60%, at 28,695.67, the S&P 500 was down 14.10 points, or 0.43%, at 3,243.75. The Nasdaq Composite was down 33.40 points, or 0.37%, at 9,058.79.
Safe-haven assets such as gold surged after the air strike, boosting shares of miners Newmont Goldcorp, Kirkland Lake Gold Ltd and Barrick Gold Corp between 0.3% and 0.8%.
Weapons makers Lockheed Martin Corp and Northrop Grumman Corp were the biggest boost to the S&P 500 index, gaining more than 4% after the air strike in Iraq.
Meanwhile, oil prices jumped about 2%, denting shares of American Airlines Group Inc and Southwest Airlines Co .
Meanwhile, Tesla Inc shares hit a fresh record high after beating estimates for vehicle deliveries in the fourth quarter.
Declining issues outnumbered advancers for a 1.17-to-1 ratio on the NYSE and a 1.50-to-1 ratio on the Nasdaq.
The S&P index recorded 16 new 52-week highs and one new low, while the Nasdaq recorded 45 new highs and 10 new lows. (Reporting by Manas Mishra and Medha Singh in Bengaluru; Editing by Anil D'Silva and Shounak Dasgupta)