Signs of stabilization in China's economy supported European stocks, however, which closed up more than half a percent, and the data also pushed crude prices higher.
Also Read: Wall St Weekahead: US investors pin hopes on retail therapy
Comments from Fed officials this week that indicated a desire to start cutting bond purchases gave traders a reason to pull back from last week's records.
The repositioning of trades built up around the Fed's bond-buying program has been a factor in market moves this week, along with the lighter volume heading into the end of summer.
The uncertainty prompted investors to pull a record USD 3.27 billion out of US-based funds that hold Treasuries in the latest week, data from Thomson Reuters' Lipper service showed. The outflow from Treasury funds in the week ended August 7 was the biggest since Lipper records began in 1992.
Bond prices were lower on Friday as investors took profits on the week's gains. The 10-year Treasury note fell 4/32 in price, to yield 2.56 percent.
US stocks extended declines by midday as investors found few catalysts in light volume, prompting traders to pull back from last week's records. The Fed's stimulus has been a major driver in the equity rally this year that has pushed the S&P 500 up about 18 percent.
"They are basically saying we have pumped the market full of liquidity for the last five and a half years and given you a fantastic stock market and now you are going to have to stand on your own two feet," said Uri Landesman, President, Platinum Partners in New York.
"Until the market proves it can do that, it is going to be a lot easier to do that from a lower level and that is what is going to happen."
The Fed has said it will reduce its USD 85 billion in monthly purchases later this year if the economy progresses as expected.
Dallas Fed President Richard Fisher reiterated on Thursday that the central bank remained open to trimming its purchases from September if economic data keeps improving, and there was no fresh information due on Friday that would help clarify the situation.
The uncertainty had driven the dollar lower this week but the currency bounced up on Friday with the dollar index gaining 0.2 percent.
"The market was very long of US dollars assuming the Fed would taper sooner rather than later, and the Fed has pushed back against that," said Jane Foley, senior currency strategist at Rabobank.
The Dow Jones industrial average dropped 109.11 points, or 0.70 percent, to 15,389.21. The Standard & Poor's 500 Index fell 7.06 points, or 0.42 percent, to 1,690.42. The Nasdaq Composite Index gave up 10.27 points, or 0.28 percent, at 3,658.85.
But Europe's broad FTSE Eurofirst 300 index gained 0.6 percent as the latest data out of China lifted stocks of mining companies higher. World shares dipped 0.1 percent.
The run of upbeat Chinese data in the past two days has helped to ease investor concerns that a sharp slowdown in the world's second-largest economy could derail global growth.
China said factory output rose 9.7 percent in July, beating forecasts, and retail sales grew 13.2 percent while inflation held steady. The data added to Thursday's trade figures showing exports from the Chinese economy running at a surprisingly strong pace.
The promising numbers lifted Brent oil above USD 107 a barrel, a day after it hit the lowest levels in more than a month. Brent was up USD 1.11 to USD 107.79, while US crude gained USD 2. to USD 105.06.
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