Updated from 4:08 p.m. EDT

The Dow and the Nasdaq plummeted to their lowest closing level in nearly a month Tuesday after investors interpreted testimony from Federal Reserve Chairman Alan Greenspan as a signal that the economy is one step closer to interest rate hikes.

The Dow Jones Industrial Average dropped 123.35 points, or 1.18%, to 10,314.50 after being positive for most of the day. The S&P 500 lost 17.73 points, or 1.56%, to 1118.09, and the Nasdaq Composite was off 41.80 points, or 2.07%, to 1978.63. The 10-year Treasury note went from flat to trade down 15/32 in price, yielding 4.45%, while the dollar surged against the euro and the yen.

The Dow's loss was moderated somewhat by the performance of General Motors ( GM), which rose 3.5% on better-than-expected first-quarter earnings. But 28 of the Dow's 30 components finished lower.

Volume on the New York Stock Exchange exceeded 1.5 billion shares, while over 1.9 billion changed hands on the Nasdaq. Decliners dominated advancers by about 7 to 2 on both exchanges.

While not directly addressing the near-term outlook for short-term interest rates in his prepared statement, Greenspan did signal that a period of rising interest rates was materializing by acknowledging that banks were preparing for a higher rate environment and that the risk of deflation had disappeared.

He said that in the last few years, banks made up for weakness in the market for business loans and the underwriting of equity securities by offering consumers household credit in a low interest rate environment. As rates rise, some banks will "undoubtedly be hurt by rising rates," Greenspan said. "However, the industry appears to have been sufficiently mindful of interest rate cycles and not to have exposed itself to undue risk."

"It's clear that the Fed is paving the way for rates to move higher sooner than anticipated," said Peter Cardillo, chief market analyst at S.W. Bach & Co. "He said deflation is no longer an issue. So, obviously, what is the issue now? The issue is strength in the economy and higher inflation, and that means higher interest rates."

"I think the Fed is going to take a pre-emptive strike against higher inflation," Cardillo added. "And it's also sending a strong message that the economy is strong enough to stand on its own two feet and it doesn't need crutches anymore."

On Wednesday at 10 a.m. EDT, Greenspan will address the Joint Economic Committee on Capitol Hill. Trip Jones, managing director at SunGard Institutional Brokerage, said that today's testimony from the Fed chairman was only a warm-up for tomorrow, when he will address the state of the economy. "People will definitely be on edge leading up to that speech," he said.

Corporate news continued to deluge the market Tuesday, one of the biggest days for earnings this quarter, with three dozen S&P 500 companies scheduled.

After the closing bell, Motorola ( MOT) posted a stronger-than-expected quarterly profit as the company said it expanded its share of the global handset market. The company said it earned $609 million, or 25 cents a share, compared with $169 million, or 7 cents a share, in the year-ago quarter. Its shares closed down 48 cents, or 2.9%, at $16.22, but had gained nearly 20% in after-hours trading.