Did the Fed overdo it?

The last two weeks have brought a crush of surprisingly weak economic data, raising the question of whether the Fed, in its effort to slow the pace of growth, hiked interest rates too much. If it did, then maybe it will have to cut the

fed funds rate to keep the economy from tipping into recession.

Some economists think so. But more are saying it's still too soon to draw that conclusion. There are reasons to think the recent batch of feeble data is overstating the case, they say. And, they point out, financial market conditions have eased in both the bond and stock markets, which should help the economy perform better in the months ahead.

With a few notable exceptions, the economic data calendar has been a parade of losers lately.

Factory orders

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) dropped a record 7.5% in July. The

Chicago Purchasing Managers' Index

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Purchasing Managers' Index

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) both dropped below 50 in August for the first time since early 1999, indicating a contracting manufacturing sector.

Construction spending

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) fell for the fourth month in a row in July. And private-sector job growth, as measured by the

employment report

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), slowed to a jog in August.

"I can't remember the last time we had that many weak numbers in a row,"

Lehman Brothers

senior economist Ethan Harris says. "You have to feel a little nervous about whether growth might be hitting a real air pocket here."

Economic numbers like the ones we've been seeing point to a third-quarter economic growth rate of about 3.3%, Harris says. The Fed has indicated it thinks the economy can grow at a pace between 4.25% and 4.5% without causing inflation to accelerate.

"In a sense they've already overshot slightly," he says. "They want to see growth below potential" to offset the effect of several quarters of above-trend growth. "But not

that

much below."

Now That We Know That, What Do We Do?

So, will the Fed cut the fed funds rate? Rate cuts have been known to sneak up,

ClearView Economics

chief economist Ken Mayland notes in a published comment. "It is a historical fact that the turn in rates comes faster than forecasters usually expect," Mayland says. "For instance, when the Fed raised the fed funds rate by 50 basis points in February 1995, nobody that I am aware of projected that the Fed would begin cutting interest rates by July."

Still, most economists say it's premature to start thinking about a rate cut.

Some say there still isn't enough evidence of a lasting slowdown. "We've got a slowdown and that's great, but we don't know if it's going to stick, if it's long enough, or if it's enough," says Diane Swonk, chief economist at

Bank One

. "There are still a lot of questions that the Fed is grappling with."

Chief among them, Swonk says, is whether productivity growth will continue to outpace wage growth. If productivity is increasing at a faster rate than wages are, wage inflation should not lead to price inflation. "We have a race between productivity growth and wage gains," Swonk says. "Now, productivity is winning and that's great, but wages are unbounded. If labor markets are too tight" -- and they remain extraordinarily tight, with the unemployment rate still near a 30-year low -- "then wages will win."

At the same time, there are reasons to doubt that the recent string of sorry economic reports will be followed by equally pathetic numbers in the months ahead.

Michael Moran, chief economist at

Daiwa Securities

, says there were "probably temporary factors at work" in the reports. For example, construction spending was exceedingly strong from November to March, making the drops that occurred in the next four months look like payback. Also, Moran says, defense spending and inventory-building were unusually strong during the second quarter, setting up a third-quarter payback scenario in manufacturing as well. Signs of weakness in consumer spending, for their part, could be attributable to unseasonably cool weather.

"We're clearly backing away from the rapid pace of growth of last year and the early part of this year, and the Fed is on the sidelines, but I'm not yet ready to say their next move is an ease," Moran says.

Another reason to doubt that the Fed will cut rates is that financial markets are providing ample stimulation for the economy. Following Treasury bond yields, mortgage interest rates have declined substantially, with

Freddie Mac's

average three-year commitment rate recently dropping below 8% for the first time this year. That should give the construction sector a shot in the arm.

Oil prices have stabilized. And stocks may be shaking off the lethargy that kept them range-bound during the first half of the year. Rising stock prices should lead to faster rates of consumer spending, and continued high rates of business investment.

The behavior of the stock market is among the best pieces of evidence that the interest rates set by the Fed are not too high, says

Morgan Stanley Dean Witter

chief U.S. economist Richard Berner. "We've had a nice rally in all financial assets," he says. "If rates were too high, people would probably be more worried about the stock market."

The good news is that growth may have slowed enough to enable the Fed -- in its pronouncements after meetings of the

Federal Open Market Committee -- to stop describing the economy as running a higher risk of too-high inflation than of too-slow growth, and start describing the risks as balanced.

If economic reports continue to show slower growth and low inflation, that could happen at the FOMC's next meeting on Oct. 3, Lehman's Harris says. The only reason to maintain the bias to hike rates, he says, "is for PR purposes -- to show they're on the job, and to keep the stock market from igniting too much. Because the economic fundamentals don't justify it."