In this interest rate-adjustment period, the slightest breeze of inflation jitters came in the form of hawkish talk out of the Bank of England Monday afternoon. BOE Governor Mervyn King's jawboning on inflation was enough to derail the stock market's attempt to sustain Friday's rebound.

Stocks and bonds remained attached at the hip, with yields moving inversely to equities, which ended virtually flat on the day. Yields on the 10-year note rose modestly Monday, and stocks struggled to find their footing amid muted deal flow and no economic data.

The major stock indices spent much of the afternoon up slightly, but their move was unconvincing as selling took over in the afternoon. Investors in both markets await more clues on economic growth in Wednesday's May retail sales report, and on inflation with the Labor Department's reports on producer and consumer prices on Thursday and Friday, respectively. The yield on the 10-year note rose to 5.13% from 5.12% at Friday's close.

The

Dow Jones Industrial Average

was flat at 13,424.96 while the

S&P 500

added 0.1% to close at 1509.12; the

Nasdaq Composite

finished up 0.05% at 2572.15.

As traders search for market tops in this uncertain period, some of the companies that have experienced a nice run aren't squeezing any more gains out of what on another day might be good news.

Take

Apple

(AAPL) - Get Report

, which fell 3.5% on the day investors discovered it is in talks to offer new movie downloads on its iTunes service and that it will offer a new operating system, Leopard, in October. Some traders were disappointed Apple won't fully open the iPhone's software code to developers.

On the flip side, stocks that have underperformed in the latest three-month rally seemed to enjoy a disproportionate benefit from some positive news.

Ford

(F) - Get Report

and

General Motors

(GM) - Get Report

gained 2% and 2.5%, respectively, on news that Ford is mulling a sale of luxury brands Jaguar and Land Rover.

Alex Grace, a trader and consultant to hedge funds, wrote this weekend that the S&P 500 has put in a "macro top," meaning a 10% correction from the high began last week. He tells the tale of a

Starbucks

(SBUX) - Get Report

barista who bragged to him on the weekend that she bought Apple, noting that he wasn't 100% sure about his call for a correction until that moment.

Momentum is great for those who can catch it and trade it, but for most investors wondering if the risk is worth the reward to stay in the stock market as interest rates rise, the debate continues. Much of the back and forth is about whether the bond yields are a signal that higher inflation is here and that the

Federal Reserve

will have to respond with interest rate hikes, or just a sign that bond investors have caught on to the rebound in economic growth.

"The key for stocks is

how

interest rates rise," writes Rod Smyth, chief investment strategist at Wachovia Securities. As long as interest rates rise on the back of real economic growth rather than inflation expectations, the higher yields will "continue to stall the S&P 500's three-month advance and tame recent exuberance, but will not 'kill' the bull market," he adds.

Smyth believes the backup in rates is due to economic strength rather than inflation. He is encouraged the U.S. dollar strengthened and the price of gold fell as yields rose last week -- "both of which suggest inflation is not a concern."

Another measure of inflation expectations, the risk premium on inflation-protected Treasury bonds, has risen of late, indicating higher inflation ahead. But it has risen only to the top end of its recent range, while bonds are breaking out beyond their recent range. The disconnect suggests inflation expectations are still contained.

Indeed, bond yields are breaking out more, likely because of influences such as foreign central banks diversifying their portfolios and increased demand for yield, writes Tony Crescenzi, fixed income strategist at Miller Tabak, and contributor to

RealMoney.com.

"The main issue here is that the 26-year cycle for bonds is coming to a head," says Louise Yamada, chief technical analyst at Louise Yamada Technical Research Advisors. Every rise in bond yields since 1981 has failed to exceed the prior rise in yields, until now.

Over the past five years, breakouts and breakdowns have had no follow-through, says Yamada. Bond yields had hugged the 3% to 5% range until last week's breakout.

Now, "an investor has to change his or her mentality towards bonds," she says.

But Yamada, Smyth and others agree that even such a major shift does not have to mean an end to the stock market's run. A correction or a longer period of consolidation may be at hand, but the "global bull market is in place," says Yamada.

Michael Darda, chief economist at MKM Partners, agrees, writing that now is not the time to become cautious on stocks. With the Fed likely to keep the fed funds rate at 5.25%, the odds are that the S&P 500 can continue to climb. Darda writes that in five periods of at least a year-long flat fed funds rate, the S&P 500 has returned an average of 26.2%.

In a declining stock market, it may feel worse to pay 5 bucks for a carton of milk or over $3 per gallon at the pump. But the Fed assesses inflation by watching core levels.

Core PCE has been declining and hovers at an annual rate of 2% -- the top end of the much discussed comfort zone. Core CPI is running at 2.3% annually, down from a cycle high of 2.9% in September 2006.

If the trend in core inflation continues in that direction, the Fed is unlikely to budge, bond market fears or not.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

here

to send her an email.