NEW YORK (CNN/Money) - Bonds dropped Tuesday as traders received news of the strongest Consumer Confidence index figures in three years, prompting concerns about inflation and interest rates.

Traders squared their books ahead of Wednesday and Thursday's Federal Reserve policy meeting.

The dollar gained on the euro and the yen.

The benchmark 10-year note fell 17/32 of a point to 101-17/32 to yield 3.97 percent, up from 3.91 late Monday when bonds posted a modest rally. The 30-year bond slid 27/32 of a point to 117-19/32, erasing all the previous session's gains, to yield 4.25 percent, up from 4.20 in the previous session.

Treasury prices and yields move in opposite directions.

The five-year note lost 10/32 of a point, yielding 3.76 percent, while the two-year note lost four ticks to yield 3.65 percent.

The Conference Board's Consumer Confidence index rose to 105.8 from a revised reading of 103.1 in May. Economists had predicted a rise to 104.

"The improvement in consumers' mood suggests that business activity and labor market activity will continue to pick up over the next several months," Lynn Franco, director of the Conference Board's consumer research center, said in a statement.

Bond traders interpreted the figures as a sign that inflation might lie ahead, as well as a possible influence on the Fed's upcoming rate decisions.

Traders will likely also take a wait-and-see attitude ahead of the Federal Open Market Committee scheduled for Wednesday and Thursday as they keep a wary eye on crude prices.

Market fears that sharply higher oil prices could slow economic growth pushed longer-dated debt higher and encouraged the yield-flattening curve Monday, resulting in a mild rally. The Treasury market interpreted rising oil prices as inflationary in the previous week and prices dipped.

The debate over whether higher oil prices are inflationary or a drag on the economy will be heavily influenced by the Federal Reserve's decision on interest rates.

The June Consumer Confidence report, released Tuesday morning, indicated that higher energy prices did not weigh on sentiment last month. The Conference Board's June survey came in at 105.8, up from the revised May reading at 103.1. Economists surveyed by Briefing.com had forecast a rise to 104.

The market assumes another quarter-point short-term interest rate hike is ahead this week, which would bring the federal funds rate to 3.25 percent, the Fed's ninth increase in its current tightening cycle.

But it is the postmeeting statement that will attract the most attention as markets search for clues as to how fast and how far the central bank will take its current monetary tightening program. Key points are comments on economic growth, the employment market and inflation.

In currency trading, the dollar bought ¥110.01, up from ¥109.29 late Monday, with the yen hovering near an 8-1/2-month low against the dollar as concerns grew that high oil prices would hamper Japan's economic recovery.

Meanwhile, the euro bought $1.2056, down from $1.2161 in the previous session.