WASHINGTON - The ongoing weakness in the money supply may be signalling another slowdown in the U.S. economy in the months ahead that will force the Federal Reserve to cut short-term rates again, according to some analysts.

While the bond market is still enjoying a ride following the dramatic pre-Fourth of July move by the Fed to lower the discount rate to 3%, there is evidence that sluggish demand for money and credit reflects deep-seated economic problems that may need even more stimulus, these analysts say.

One partial explanation for what is going on comes from the fixed-income research department of Dean Witter Reynolds Inc., which examined the conventional explanation linking weakness in the money supply to the stampede by investors in stock and both funds.

Because mutual stock and bond funds are not counted in M2, some Fed officials have argued that the slow growth in money simply represents asset-shifting by household investors redeeming bank certificates of deposit and seeking to capture higher yields in mutual funds.

M2 includes currency in circulation, checkable deposits, money market mutual funds, and small certificates of deposits

Federal Reserve Board Chairman Alan Greenspan in the past has argued that over the long term, growth in M2 is key predictor of economic activity. On the other hand, if what is happening to M2 can be explained in terms of changing savings patterns by investors, Mr. Greenspan can argue there is less of a compulsion to ease monetary policy.

Since the fourth quarter of last year, M2 has increased a meager 1.6% in nominal terms. After increasing early in 1992, it flattened out in March and then began falling. In the latest reporting period for the week ended June 15, M2 fell $2.6 billion, to $3.465 trillion.

The Dean Witter analysis uses the Fed's latest flow-of-funds data from the first quarter, the most recent information available, and concludes that much of the money pouring into mutual funds probably came from the wave of corporate refinancings to take advantage of the drop in interest rates. As corporations called high-yielding corporate bonds and issued new debt, household investors put the money from the called bonds into stock and bond funds.

"While there is no doubt that individual holdings of bond funds have literally exploded in recent months, the Federal Reserve data imply that M2 deposits may not be an important source for these investments." the firm's analysts concluded in a June 26 market letter.

"My thesis really is that M2 could be signaling some problems for the economy," said William Sullivan, director of bond market research for Dean Witter. "It's not just portfolio shifting that is taking place, and I think the Fed came to that conclusion last week."

The Fed's action cutting the discount rate came shortly after the Labor Department's report that the jobless rate in June jumped to 7.8%, the highest rate in more than eight years.

A Fed official who requested anonymity agreed with the Dean Witter analysis, although the official cautioned that the figures in flow-of-funds report were exaggerated by seasonal and technical adjustment problems. "That's not an unlikely scenario," the official said. "You did see a lot of corporate bonds that were paid down."

The official estimated that non-financial institutions issued net debt at an annual rate of $80 billion in the first quarter while gross issues totaled $150 billion. "I don't think there's any question" that a lot of the bonds paid "had to go into the mutual funds," the officials said.

According to the Fed's flow-of-funds report, households liquidated corporate bonds at an annual rate of $120 billion, small-time deposits by $21.7 billion, and Treasury securities by $33.1 billion. Holdings of mutual fund shares for the same period jumped $167.1 billion and accounted for well over half of total investments.

Figures from the Investment Company Institute, the trade group for the mutual fund industry, confirm the continuing boom in mutual fund investing. Through May, the most recent month for which figures are available, net sales of bond funds totaled $48 billion, more than double the $22.5 billion for the same period in 1991. Sales of stock funds totaled $35.1 billion, nearly three times last year's $12.4 billion.

Lacy Hunt, chief U.S. economist for HSBC Holdings, said he is convinced that if the money supply does not start growing in the next month, Fed officials will have to consider additional rate cuts. Banks continue to restrict lending and demand for credit is weak, Mr. Hunt said.

The latest report from the Fed on commercial and industrial loans extended by banks for the week ended June 24 shows outstanding loans of $276.7 billion, down $32.4 billion from a year earlier.

"M2 has an excellent record in predicting economic activity," said Mr. Hunt. "I am not a great monetarist, but I respect M2. It is an indicator for all times and all seasons."

Last year, growth in M2 flattened during summer and the economy dipped to nearly zero growth by year's end. Bush administration officials, notably Treasury Secretary Nicholas Brady, have argued that history could be repeated this year if the Fed does not boost the money supply by trimming rates. Mr. Bush argued yesterday in a television interview that it may be necessary for real rates, or rates adjusted for inflation, to drop below zero.

Fed policymakers are split on how to interpret the money supply figures. According to the minutes of the May 19 meeting of the Federal Open Market Committee released last week, some officials argued that they signal economic weakness, while others emphasized the shift by investors to stock and bond funds.

There are actually three schools of thought within the Fed on the issue, according to Alan Jacobson, an analyst with County NatWest, USA. Some members of the FOMC emphasize M1, a narrower measure of the money supply, while others say the weakness in M2 still must be taken seriously and yet a third group argues that M2 remains important in the long run but must be temporarily set aside.

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