NEW YORK (CNN/Money) - Treasury prices slipped Wednesday as an attempt to build on Tuesday's gains was reversed by mortgage-related and hedge-fund selling.

Meanwhile, the dollar traded higher against the euro but continued to struggle versus the yen as international investors took money out of the European currency and invested in its Japanese counterpart.

At around 4:00 p.m. ET, the dollar bought ¥118.19, down from ¥118.27 late Tuesday afternoon, while the euro bought $1.1116, down from $1.1139 late afternoon Tuesday.

The dollar had been on a roll lately, hitting new 3-1/2 month highs Monday versus the euro before retreating Tuesday against most other major currencies. International investors have been responding to increasingly positive U.S. economic news and mostly lackluster reports from different European nations, which have made the greenback more appealing.

Tuesday's strength in the bond market came in a nervous flight back to the safe embrace of Treasurys after deadly bomb blasts in Iraq and Israel frayed investors' nerves.

As the geopolitical scene calmed on Wednesday, the Treasury market focused on the improving economic outlook in the U.S. and its ability to absorb higher interest rates.

The benchmark 10-year note fell 18/32 of a point in price to 98-16/32, yielding 4.44 percent, up from 4.37 percent late afternoon Tuesday. The 30-year bond dropped 21/32 in price to 101-8/32, raising its yield to 5.29 percent from 5.25 percent late Tuesday afternoon.

The five-year note lost 14/32 of a point to 99-20/2, yielding 3.34 percent, while the two-year note shed 4/32 of a point in price to 99-14/32, yielding 1.80 percent. Treasury prices and yields move in opposite directions.

Bond traders emphasized that the market was seasonally thin and it did not take much selling to move prices sharply.

"It finally feels like summer has arrived," said Michael Cloherty, a fixed-income strategist at Credit Suisse First Boston. "Liquidity is really lacking, and the market's all flow-driven -- fundamentals are not at the forefront."

He noted comments from Richmond Federal Reserve President Alfred Broaddus earlier had been largely favorable for bonds, and yet the market hardly reacted.

Since the Federal Open Market Committee meeting on Aug. 12, dealers have debated whether an "accommodative" Fed policy could still leave the door open to slightly higher rates.

Short-term rate futures are pricing in at least one 25-basis-point hike in the Fed funds rate by mid-2004, although most economists doubt the Fed will move that soon.

In a television interview with CNBC, Broaddus said the Fed could remain accommodative until the output gap, which measures unused labor and production capacity, closes.

"That's quite generous of him because the gap is very large right now," CSFB's Cloherty said. "We reckon it would take six consecutive quarters of GDP growth above 5.0 percent to shrink it."

However, there is much talk in the market about what "accommodative" might mean, with some concerned the Fed might feel it can raise rates to, say, 2.0 percent, and still be accommodative.

"We think this concern is misplaced since the Fed must know that the second it starts to hike [interest rates] the market will anticipate a whole cycle of tightening and yields will rocket," Cloherty argued. That was one reason CSFB believes the Fed will stay on hold all the way to 2005.  

-- Reuters contributed to this report.