The AI boom and consumer spending are fueling expansion

An investment boom in artificial intelligence is fueling the U.S. economy.

Expensive gas, higher inflation, a stalemate with Iran and rising interest rates - no matter. The U.S. economy appears to have sped up in the early fall.

The latest evidence? A pair of surveys by S&P Global that showed businesses expanding in September at the fastest pace in more than four years.

"Business is clearly booming now in both manufacturing and services," said Chris Williamson, chief business economist at S&P Global Market Intelligence.

The upturn in the economy comes as something of a surprise. A few months ago, most economists had expected growth to slow toward the end of the year.

Stubborn inflation was expected eat up wage gains and act as a drag on household spending, especially after families used up most of their large tax refunds. Consumer spending is the main engine of economic growth.

High energy prices and difficulty in obtaining key supplies, meanwhile, were supposed to restrain businesses.

Instead, consumer spending seems to have accelerated. Retail sales surged in August, and credit-card spending also increased at a solid 4.5% annual pace, Bank of America Institute data showed.

Rising demand, in turn, has allowed businesses to step up production of goods and services.

Tying it all together is a massive boom in artificial intelligence.

Businesses are spending hundreds of billions of dollars to build data centers and buy the components needed to run the increasingly controversial technology.

The AI boom has resulted in more demand for steel, lumber, plastics, electrical parts and computer chips - not to mention engineers, software developers and construction workers.

In its most recent estimate, the Atlanta Federal Reserve said the U.S. economy is on track to grow at a blistering 5.1% annual pace in the three months from July through September.

Economists who advise the American Bankers Association predict a more modest 2.7% increase in gross domestic product in the third quarter, but even that rate of growth would be well above the norm since the turn of the century.

Th resilience of consumer spending stands out.

In an era of high inflation, Americans have found ways to get more value from the dollars they spend - trading down, waiting for deals or finding cheaper substitutes.

A clear divide has also opened up, however. Well-to-do people who have seen their investments soar represent a bigger slice of total consumer spending as their wealth increases.

Wall Street DJIA SPX veteran Ed Yardeni of Yardeni Research contends that baby boomers are not only doing much of the spending, but they are giving lots of money to their kids so they can spend more, too.

Yet an estimated 50 million households are not invested in the stock market. For them, life is more of a struggle.

"Those who have participated in the stock market are feeling the wealth effect," said Mona Mahajan, head of investment strategy at Edward Jones. "Those who haven't participated are feeling the inflation pinch more than anything else."

American businesses aren't free of stress, either.

They are coping with rising prices of supplies along with problems trying to obtain them due to tariffs or the shipping bottleneck in the Strait of Hormuz.

The worry is that businesses will try to pass their own extra costs on to customers and thereby exacerbate inflation. Making matters worse has been a big increase in gas and diesel prices after the U.S. conflict with Iran flared up again in August.

Higher energy costs will "add further to the upward pressure on selling prices and inflation in the coming months," Williamson of S&P Global said.

If inflation heads higher or simply fails to slow, the Federal Reserve is almost certainly going to raise interest rates again. The Fed increased a key short-term rate last week for the first time in three years.

Higher borrowing costs would slam an already depressed housing market, potentially trip up the bull market in stocks and perhaps take a big bite out of U.S. growth, some economists say.

Put another way, the economy could look a whole lot better if not for chaos that has enveloped it this year.

"One cannot overlook that growth could have been stronger - potentially with a 3% handle - and inflation lower- closer to the Fed's 2% target - in the absence of those shocks," said chief economist Gregory Daco at EY Parthenon.

-Jeffry Bartash