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Can the economy handle inflation?

With Wall Street's fears of inflation confirmed by the Federal Reserve, investors are now looking for proof that the economy will be strong enough to handle the increased pricing pressure and more expected interest rate increases.
/ Source: The Associated Press

With Wall Street's fears of inflation confirmed by the Federal Reserve, investors are now looking for proof that the economy will be strong enough to handle the increased pricing pressure and additional expected Fed interest rate increases.

On Tuesday, the Fed raised its target for the overnight bank loan rate by a quarter point to 2.75 percent, the seventh in its current cycle of increases. Trading in federal funds futures suggest that investors are betting that central bankers may follow that with a half point hike in either May or June.

That leads Wall Street to two important questions. Will consumers be able to handle higher prices now that parts of corporate America appear to finally be gaining pricing power? And will companies be able to continue expanding as the cost of raising capital rises?

The answers will start coming in the week ahead as key pieces of economic data will shed light on the strength of consumer spending and the health of the overall economy. And that could lead to a volatile week on Wall Street.

This past week, stock indexes tumbled for a third straight week, precipitated by the Fed's statement that inflationary pressures are building in the economy. Despite falling sharply most of the week, oil futures remained above $54 a barrel as well. For the week, the Dow Jones industrial average lost 1.76 percent, the Standard & Poor's 500 index fell 1.53 percent and the Nasdaq composite index slid 0.83 percent.

Year-to-date, the Nasdaq remains far behind the other indexes, having lost 8.48 percent, as investors abandoned the technology sector and riskier small-cap companies. The Dow is down 3.15 percent, and the S&P 500 has fallen 3.34 percent so far this year.

This week: Labor jobs report
In the coming week, investors will get strong gauges of economic health and how consumers, who account for two-thirds of economic activity, are faring. On Friday, the Labor Department will release its monthly job creation report, one of Wall Street's closely watched barometers.

Economists are forecasting that the economy added 225,000 jobs in March, down from a gain of 262,000 in February. In this case, a number slightly above or below the estimates would be ideal, since very low job growth calls into question the state of the economy, while high job growth could increase consumer demand and result in rising prices.

Also on Friday, the Institute for Supply Management's index will give a reading on the state of industry. ISM index readings above 50 suggest that manufacturing is expanding, and economists are forecasting that it will come in at 55 for March, down slightly from a 55.3 reading in February. Again, a surge in growth could prompt the Fed to raise borrowing costs at a faster pace in an attempt to keep prices in line, while sluggish growth will be seeing as troublesome for corporate profits.

Consumer confidence is expected to take a hit in March due to declining stock prices and soaring oil and gasoline prices. The Conference Board's consumer confidence index, due Tuesday morning, is expected to come in at 103.3 in March, down from 104 in February.

Finally, on Wednesday, the Commerce Department will release its final figures on fourth quarter gross domestic product growth. Economists are expecting the agency to say that the economy expanded at an annualized rate of 4 percent in last year's final quarter, up from a preliminary estimate of a 3.8 percent growth rate.