Once again, it's looking like halftime for the Federal Reserve.

Until recently there was little doubt among economists that the

Federal Open Market Committee would cut its

fed funds interest rate target by a quarter-point, to 3.75%, next week. But a slew of earnings warnings and a spate of weak economic data have an increasing number of market watchers saying they won't be surprised to see a half-point cut after the FOMC meets June 26-27.

With the economy stabilizing and rates having dropped 250 basis points since Jan. 1, market observers have felt the easing cycle is nearing its conclusion. Already the bond market is pricing in expectations that the Fed will raise rates by the beginning of next year.

But the happy prognosis for economic recovery that underlies those assumptions took a number of blows last week. Profit warnings from

JDS Uniphase

(JDSU)

and

Nortel

(NT)

suggested a capital spending environment even worse than investors had come to expect.

Anecdotal evidence collected by regional banks for the Fed's

Beige Book showed an economy still on the ropes. Distressingly, areas that had thus far held up well -- construction, tourism -- deteriorated. Meanwhile, fresh data showed that Japan may again be teetering on the brink of a recession. Inflation soundings for a number of European countries argued that the

European Central Bank

will

not be able to cut rates aggressively -- and that likely means a slower Europe.

And then there was Friday's release of U.S. industrial production and capacity data for May -- a dismal set of numbers. Production fell by 0.8%, its eighth decline in a row (last time that happened was 1982). Capacity utilization -- the amount of production capacity companies are using -- fell to 77.4%, its lowest level since August 1983.

"No way to sugarcoat it," says Ethan Harris, senior economist at

Lehman Brothers

. "Those were ugly numbers -- just ugly."

Half-Measures

The economists at Lehman now expect the Fed to cut rates by a half-point at next week's meeting. They're not alone.

Merrill Lynch

chief economist Bruce Steinberg also moved his forecast to a half-point cut because "the economy hasn't bottomed yet and would probably be in recession if not for the rapid-fire easing that has already occurred."

Salomon Smith Barney's

economists, too, moved into the half-point camp.

"The corporate news is just disastrous," says Salomon senior economist Steven Wieting. "The earnings numbers look like they were at the trough of the last recession." Wieting reckons that

S&P 500

earnings will fall by 18.2% in the second quarter and drop by another 12.1% in the third quarter.

Most economists continue to call for a cut of just a quarter-point next week, but the half-point camp is growing. A

Bloomberg

poll released Tuesday has economists at eight of 25 primary government bond dealers predicting a half-point easing, with the rest expecting a quarter-point; a

Reuters

poll last week had just six economists predicting a half-point move.

"I think the Fed, despite the weak economic data, has shifted from an aggressive easing mode to a more gradual one," says

Banc of America Securities

chief economist Mickey Levy.

In recent speeches, several Fed officials have struck a tone of moderation, emphasizing how deeply rates have been cut already and noting that a tax cut is on the way. Because monetary policy acts with a lag, it won't be until the second half of 2001 that rate cuts affect the broad economy. Energy prices have also begun to moderate, which should also ease the strain.

Still, while these things suggest a cut of just a quarter-point to most economists, it's not as if anyone feels certain.

"We're leaning toward 25

basis points because they've done a lot and fiscal policy is coming," says Bill Dudley, director of U.S. economic research at

Goldman Sachs

. "But we wouldn't be surprised if they did 50."

Regardless of how deep the next cut is, Dudley thinks the FOMC will signal that it remains willing to continue to cut rates. The economy, after all, has not changed that much over the past half-year. The manufacturing sector continues to deteriorate; despite this, the consumer continues to hold up remarkably well. At some point the combined effects of monetary and fiscal policy should bring about recovery, but exactly where that point will be is a matter of conjecture.