The inherent optimism of M&A activity (and speculation thereof) gave the stock market a boost ahead of the Federal Reserve's final meeting of 2006.

The stock market rose modestly Monday amid uncertainty about the future of the U.S. economy and the direction of interest rates. While most expect the Fed to stay on hold, investors will scour the accompanying statement for hints at future rate cuts, as recent data point to declining inflation threats.

All three major indices finished the day up 0.2% with the Dow Jones Industrial Average closing at 12,328.48, the S&P 500 at 1413.04 and the Nasdaq Composite at 2442.86.

The market on Monday was moving on speculation rather than on real deals. Shares of Internet travel company Sabre Holdings ( TSG) were up 7.6% on reports that the company will be bought for more than $4 billion by a private equity firm. Biomet ( BMET) gained 4% on speculation that the U.K.'s Smith & Nephew and/or Johnson & Johnson ( JNJ) might make a bid for the company.

In actual deal-making, @Road ( ARDI) jumped 7.9% after agreeing to be acquired by Trimble Navigation ( TRMD) for about $496 million in cash and stock.

Also, American International Group ( AIG) gained 0.9% after the insurance company announced that it agreed to buy U.S. port operations from Dubai Ports World.

"M&A always boosts the market," says Art Hogan, chief market analyst at Jefferies & Co. "It is a vote of support."

Elsewhere, shares of mining company Phelps Dodge ( PD) dropped 0.7% on news that hedge fund SAC Capital Advisors bought a stake and opposes its purchase by Freeport-McMoRan ( FCX). SAC owns a 5.1% stake in Phelps Dodge. Shares of Freeport declined 0.7%.

Among other stocks in the news, Citigroup ( C) gained 2% on news that the company made an initial bid for British online bank Egg, a division of the insurance company Prudential. (After the bell, Citigroup shares were recently down 1.3% on news Robert Druskin, currently head of its investment-banking group, has been named COO. Sallie Krawcheck remains on board as CFO of the banking colossus, which has been the subject of much speculation in recent days.)

Citigroup won't report earnings this week, but some other financial giants will, and expectations run high for a winning fourth quarter. Goldman Sachs ( GS) kicks off the season Tuesday, and Bear Stearns ( BSC), Morgan Stanley ( MS), Merrill Lynch ( MER) and Lehman Brothers ( LEH) will follow.

Goldman's shares were down 1.3% Monday ahead of its report. Skeptics say the brokerage stocks don't have that much farther to go, as shares of these companies have soared and supported the broad market on the back of trading revenue and M&A deals, as well as equity and debt financings. The Amex Securities Broker/Dealer index is up 24% thus far this year.

Even with such bullish news from the nexus of the nation's rain-makers, economists and investors are nervous about U.S. growth going forward and still hope for a rate cut or two as long as inflation is no longer a threat.

Last Friday's stronger-than expected November jobs report punctuated the idea that strength in the service sector more than offsets weakness in manufacturing and housing. The idea of a soft landing has solidified for many investors.

This economic landscape follows the Fed's forecast from earlier this year, which foretold a weakening economy that tempered inflation on its own. But Fed officials, led by chairman Ben Bernanke, have been hawkish in their rhetoric since they paused in August after 17 consecutive interest rate hikes. Bernanke has contended that inflation hasn't waned fast enough, even as the Treasury bond market seems to be screaming that the weak housing market heralds a recession in 2007.

But since Bernanke's Nov. 28 speech, economic data have pointed ever more to a soft landing. Housing and mortgage activity suggests that the worst of the housing market's downturn could be history, while the labor market remained robust and third-quarter unit labor costs were revised sharply downward.

The Treasury bond market, which sold off Friday on news of a strong November payrolls report, rebounded Monday. The 30-year bond gained 16/32 to yield 4.62%, while the 10-year gained 8/32 to yield 4.52%, and the two-year added 1/32 to yield 4.66%. These yields are about 10 basis points off their lows of the year, which gives bond investors some wiggle room to rally if Tuesday's FOMC statement is indeed more dovish. It also gives them room to sell off if the statement declines to acknowledge the latest data.

So, the recent history leaves stock and bond investors longing evermore for a rate cut even though they fear recession less intensely. Perhaps Bernanke & Co. will give the markets a sign of rate cuts to come -- the holiday present most traders are wishing for.
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.