Updated from 9:06 a.m. EDT

The pace of labor-market expansion eased in June, with the U.S. economy adding 112,000 jobs -- about half the consensus forecast. Friday's Labor Department report is the latest in a series of indications that the U.S. economic recovery has lost some steam, possibly giving the Federal Reserve more leeway in deciding how quickly to raise interest rates.

The unemployment rate held steady at 5.6%, matching expectations. But the Labor Department also revised down the number of jobs added in May to 235,000 from 248,000, and lowered the number created in April to 324,00 from 346,000. A smaller-than-expected rise in average hourly earnings bolstered views that inflation is benign.

Economists had expected a 250,000-job gain in June nonfarm payrolls.

Stocks were lower on the report, with the Dow Jones Industrial Average recently losing 63 points, or 0.6%, to 10,271, and the Nasdaq Composite off 19 points, or 0.9%, to 1997. Bonds rallied, with the 10-year Treasury note recently trading up 1 3/32 to yield to a seven-week low of 4.40%.

With jobs growth decelerating, the markets will have to recalculate odds of a both a Federal Reserve rate hike at its Aug. 10 meeting and the reelection of President Bush. For now, economists said, neither is a prohibitive long shot.

"The Democrats will certainly try to make an issue out of this," said Vincent Ambrose, trader at Fox Investments. "I don't think the Bush people have done a good job of trumpeting the fact that we've had really good economic numbers and job growth over the last few months. The numbers may have cooled off a little recently, but we're still seeing good growth."

Still, the report complicates the calculus for Bush, who despite all the economic progress has yet to see his approval rating bounce.

"It's clear that the markets prefer President Bush in the upcoming election, and this does not bode well for his reelection chances," said Barry Ritholtz, chief market strategist with Maxim Group and a contributor to TheStreet.com's sister site, RealMoney.com. "When you see the polls that say voters are not all that happy with the economy, you have to remember that they actually have more insight into what's going on in the real world than do us pundits and academic economists who look at the data but might not see what's really going on."

The report, which brings the four-month gain in new jobs to more than 1 million, reflected an 11,000-job decrease in the number of manufacturing jobs, a decline that followed 75,000 net additions over the previous four months. Construction hiring was flat, while service employment grew by 122,000 jobs, down from a 169,000 increase in May.

Professional and business services, which include staffing and temporary help firms, added 39,000 jobs in June. Government payrolls fell by 5,000 jobs.

Average hourly earnings rose by 2 cents in June, while the average work week fell to 33.6 hours from 33.8 hours. The manufacturing workweek was 40.8 hours, down from 41.1 in May.

One immediate beneficiary of the tumble in bond yields were homebuilding stocks. Lennar ( LEN), Hovnanian ( HOV), KB Home ( KBH) and Centex ( CTX) all held better than 2% gains in early trading.

Some -- but not all -- lenders benefited. Countrywide ( CFC) gained $1.01, or 1.4%, to $71.26, while Wells Fargo ( WFC) added 48 cents, or 0.8%, to $57.07. Sector problem child Washington Mutual ( WM), on the other hand, was down 21 cents, or 0.6%, to $37.92.