The comments by Chicago Fed President Michael Moskow unnerved investors looking to revive last week's rally after having collected profits yesterday. Retailers and other sectors dependent on consumer spending stumbled after Moskow said, "some additional firming of policy may yet be necessary to bring inflation back into the comfort zone within a reasonable period of time."

The Fed left interest rates unchanged earlier this month after raising them 17 straight times. Wall Street has rallied since then on hopes this would be the end, but one analyst said Moskow's comments could be "putting out a trial balloon" to gauge the market's reaction to a continuation of rate hikes.

"The market has discounted the likelihood of another rate increase by about a 20 percent chance for the next meeting" in September, said Scott Merritt, a U.S. equity strategist for JPMorgan Asset Management. "He might want to get that up to 50 percent to get more flexibility. If expectations get too high or low, (Fed Chairman Ben) Bernanke can't really go against it or he'll lose credibility."

The Dow Jones industrial average dipped 5.21, or 0.05 percent, to 11,339.84 after been up more than 38 points early in the session. Advancers beat decliners in relatively light summer trading on the New York Stock Exchange and the Nasdaq Stock Market.

Broader stock indicators edged higher. The Standard & Poor's 500 index rose 1.30, or 0.10 percent, to 1,298.82, and the Nasdaq composite index gained 2.27, or 0.11 percent, to 2,150.02.

Bonds held their ground, with the yield on the benchmark 10-year Treasury note falling to 4.81 percent from 4.82 percent. The dollar maintained its gains against other major currencies, while gold prices edged lower.

The 10-year treasury yields have been trading near their lowest in five months, inspired by data last week that indicated the Federal Reserve's attack on inflation was working. Several economic reports issued last week — including one that showed benign inflation data — help convinced investors the economy was headed toward a "soft landing."

Wall Street wants the economy to slow so inflation is contained but still grow enough to keep corporate profits strong. Moskow's comments helped reverse the effects of last week's gains.

The market initially ramped up after Iran's top nuclear negotiator committed to "serious negotiations" over its nuclear ambitions, giving hopes that Middle East tensions might ease. And gains from Advanced Micro Devices Inc. and XM Satellite Radio Holdings Inc. helped send technology stocks higher.

Iran is the world's fourth-largest producer of crude, and controls one of the biggest stockpiles of reserves. Investors were encouraged as oil prices held steady after yesterday's gains, with a barrel of light, sweet crude quoted at $72.63, up 18 cents, on the New York Mercantile Exchange.

But Moskow's comments unsettled investors still uneasy about interest rates.

Among the decliners were high-end retailers such as electronics chains, which could see sales curbed if higher rates spawn a drag on consumer spending. Circuit City Stores Inc. shed 80 cents, or 3.2 percent, to $24.20, while rival Best Buy Co. fell 76 cents to $46.90.

An Advanced Micro Devices executive told news services the world's No. 2 chip maker behind Intel Corp. hopes to capture 40 percent of the global market for computer processors by 2009. Shares of the company, which was upgraded by Bear Stearns, advanced $1.48, or 6.3 percent, to $24.88.

XM Satellite Radio shares spiked $2.28, or 20 percent, to $13.52 after its upgrade. An analyst for Bear Stearns said the depressed stock will soon be buoyed by positive news, such as expected regulatory approval for one of its radios in time for the holiday season.

Investors also were encouraged that Toll Brother Inc.'s full-year guidance was not a worst case scenario amid a U.S. housing slump. The luxury homebuilder posted a 19 percent drop in third-quarter profit, but that still surpassed projections and lifted the stock.

Toll Brothers added 43 cents to $25.20. Rival Pulte Homes Inc., the nation's largest homebuilder, picked up 14 cents to $29.11. D.R. Horton Inc. rose 7 cents to $21.53, and Hovnanian Enterprises Inc. increased 8 cents to $26.51.

Advancing shares outnumbered decliners by nearly 4 to 3 on the New York Stock Exchange, where preliminary consolidated volume came to a light 1.99 billion, up from yesterday's 1.87 billion. On the Nasdaq, advancers were also ahead of decliners by about 4 to 3.

The Russell 2000 index of smaller companies rose 2.43, or 0.34 percent, to 707.76.

Overseas, Japan's Nikkei stock average closed up 1.33 percent. Britain's FTSE 100 closed down 0.21 percent, Germany's DAX index rose 0.41 percent, and France's CAC-40 added 0.46 percent.