WASHINGTON (MarketWatch) — Private-sector employment growth decelerated sharply in May, a report by Automatic Data Processing Inc. showed Wednesday, casting a gloom over U.S. recovery hopes and spurring a dramatic selloff in the financial markets.

Employment in the nonfarm private business sector rose a seasonally adjusted 38,000 in May, well below the 175,000 increase expected by economists. In April, private payrolls showed an increase of 177,000, ADP said.

The ADP report confirmed fears among investors that the labor market is weakening. Weekly jobless claims have risen sharply over the past month, but analysts had been unsure how much weight to put on the data, given technical factors.

“This is exceptionally weak,” said Eric Green, chief market economist at TD Securities Inc. in New York.

“This was a dismal report, indicating a significant slowdown in job creation after six months of solid gains,” said Nicholas Tenev, economist at Barclays Capital Research.

On Wall Street, the Dow Jones Industrial Average DJIA, +1.19% slumped more than 279 points or 2.2% to 12,290. Read more on broad-based retreat for U.S. stocks following ADP data.

And in the bond market, risk-averse traders bid benchmark 10-year Treasury notes higher as their yield TMUBMUSD10Y, 0.687% sank below the 3% level for the first time since December. Read more on the data-inspired rally in Treasurys.

May ADP details

In May, employment in the service-producing sector rose 48,000, roughly one-third the 141,000 positions added during April, according to ADP. See the ADP release.

Employment in the goods-producing sector fell by 10,000 after a 36,000 increase in April.

Dow’s biggest point drop in a year

In May, employment fell by 19,000 among large businesses, but payrolls gained 30,000 among medium-sized businesses and 27,000 among small businesses.

On Friday, the government will report on U.S. nonfarm payrolls for May, data that also include government workers. Economists polled by MarketWatch now are expecting payrolls growth of 125,000 after Wednesday’s data. See related story on economist projections.

That would mark a slowdown from the healthy 244,000 jobs added in April.

New estimates on payrolls

But in light of the weak private-sector increase derived in a sampling of ADP payroll reports, a number of analysts are now expecting growth in nonfarm payrolls to be much smaller in the government’s May report.

Ian Shepherdson, chief U.S. economist at High Frequency Economics, said he would pull down his forecast for Friday’s nonfarm payroll number to 100,000 from 175,000.

Economists at Goldman Sachs lowered their nonfarm payroll forecast for May to 100,000, down from 150,000 previously.

However, Barclays Capital’s Tenev said he was hesitant to revise his forecast of a 190,000 gain in May nonfarm payrolls, pointing to a “poor track record” of ADP in predicting payrolls in real time.

On a related note Wednesday, outplacement consultancy Challenger Gray & Christmas Inc. reported that planned layoffs were 37,135 in May, down 4.3% from the prior year.

And in a separate sign of a weakening economy, the Institute for Supply Management said its manufacturing gauge fell to 53.5% in May from 60.4% in the prior month — the biggest one-month drop since 1984. Read ,more about the tumble in the ISM manufacturing gauge for May.