Inflation is coming, but is the economy strong enough?

NEW YORK -- 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.

Last 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.

Economic data

In the coming week, investors will get strong gauges of economic health and how consumers, who accounts 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 seen 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.

Earnings

First-quarter earnings season begins in earnest in April, but a handful of companies will be reporting their results in the week ahead.

On Monday, drug store chain Walgreen Co. is expected to report earnings of 48 cents per share, up from 41 cents per share in the year-ago quarter. The company's stock has seen steady growth over the past year, rising 42.2 percent from its close of $32.51 on March 24, 2004, to close Thursday at $46.23.

Two of the nation's largest electronics retailers will issue their results Wednesday morning. Best Buy Co. Inc. is expected to earn $1.54 per share, up from $1.42 per share a year ago. Best Buy shares have fallen 16.5 percent since its best close of 2004, $62 on Nov. 18, finishing Thursday at $51.74.

Rival Circuit City Stores Inc. will report its first earnings statement since rejecting a $17-per-share takeover bid earlier this month from a private equity group. Wall Street expects Circuit City to earn 55 cents per share, up from 46 cents per share in the year- ago quarter. The stock has been volatile over the past year, but is still up 48.6 percent from its close of $10.43 on March 24, 2004, finishing Thursday at $15.50.

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