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The Russell 2000 (NYSE: IWM) is in negative territory despite news of an unexpectedly strong rise in consumer spending.

At 10:10 a.m. ET, the small-cap index had declined 8.95 points, or 1.27%, to 696.77. The Dow Jones Industrial Average (INDU) was down 179.26 points, or 1.42%, to 12,402.92.

The U.S. Commerce Department reported before the start of trading that spending increased 0.4% in January, while personal income added 0.3%. Economists were expecting smaller increases of 0.2%.

The same report showed that the price index for personal consumption expenditures rose 0.4%, while the core index, which excludes the costs of food and energy, climbed 0.3%.

That makes a year-over-year increase of 3.7%, while the core index is at 2.2%. The U.S. Federal Reserve prefers the annual core index to stay within the range of between 1% and 2%.

The good news on consumption, though, was overshadowed by news that insurance giant American International Group, Inc. (NYSE: AIG) suffered the biggest quarterly loss in its history, largely due to losses related to subprime mortgages.

The Russell 2000 (NYSE: IWM) posted solid gains today as investors looked ahead to Tuesday’s Fed meeting and welcomed news of a cash injection into a major bank. The small-cap index advanced 5.68 points, or 0.72%, to 791.20. The Dow Jones Industrial Average (INDU) moved up 101.45 points, or 0.74%, to 13,727.03.

On a year-to-date basis, the Russell 2000 is up 0.48%, while the Dow has added 10.04% and the S&P 500 has climbed 7.01%.

Only the bears showed up today as investors focused their attention on the U.S. Federal Reserve’s Tuesday policy meeting. The Fed is widely expected to lower the federal funds rate, the rate at which commercial banks make overnight loans to each other, to give the economy a boost and ease financial strains.

On Oct. 31, the central bank lowered its target interest rate to 4.5% from 4.75%. During the preceding meeting on Sept. 18, the Fed voted to lower the rate to 4.75% from 5.25%.

The upbeat mood was also due to news that UBS AG (NYSE: UBS) has received a cash injection of about $11.5 billion dollars after the Swiss financial services giant became the latest casualty of the subprime mess.

The bank announced today that it has suffered $10 billion in write-downs due to bets placed on securities backed by subprime mortgages. Consequently, the Zurich-based company expects to report a loss for the fourth quarter and possibly the entire 2008 year.

The Russell 2000 (NYSE: IWM) and the other major U.S. indices opened with modest gains.
 
At 10:34 a.m. ET, the small-cap index had added 6.08 points, or 0.77%, to 791.60. The Dow Jones Industrial Average (INDU) was up 102.75 points, or 0.75%, to 13,728.33.

The futures were pointing up and stocks are rising as investors anticipate the U.S. Federal Reserve’s policy meeting on Tuesday. The Fed is widely expected to lower the federal funds rate, the rate at which commercial banks make overnight loans to each other, from the current level of 4.5%.

The ongoing, some would say intensifying, slump in the U.S. housing sector, combined with slowing growth in business spending and manufacturing, point to a decline in economic growth.

Factor in the credit squeeze, and you’ll begin to understand why many believe the Fed has no choice but to lower its target interest rate to give the economy a boost and ease financial strains.