Erich, unless there's a P&E component generating the launch files when the project is created, this is primarily an NXP bug.
I don't know whether this is ultimately a KDS or KSDK issue, but it is a bug in your software. The problem is that dot-launch files are being created with invalid debugger command strings, and this is compounded by the fact that the GDB server hangs when given these strings, and KDS hangs as well.
I'm using KDS 3.1, with a Kinetis Expert KSDK 2.0 build for the MKL17Z128. I made a brand new KSDK 2.x project, didn't even build it, and opened the launch configuration. Here's what it looks like as created by KDS/KSDK:

Look at the GDB Client Settings / Commands field. Whatever tool or component is generating the launch file, isn't escaping CR-LF correctly, and they're being put in there as literal escaped characters. Now here's all I have to do to make this launch configuration work:

The solution is exactly as PO220 explained; just replace the badly escaped CR-LF pairs with actual newlines, and the launch configuration works. This can be done in KDS as shown above; it's not necessary to use a text editor on the raw launch file.
I'm not sure how NXP didn't catch this during testing prior to release of the tools. Please fix this in the next release of your tools; this burned an hour of my time, and I suspect it's burning dozens of other engineers' hours as they try to work around this, and eventually find this forum post.