Fed's Collins Backs Another Rate Hike as Bank Margins Recover

A mixed inflation picture, but a clear lean toward tightening

Boston Federal Reserve President Susan Collins gave a nuanced account of US inflation on Tuesday, but her policy conclusion was not ambiguous. In prepared remarks to the Boston Fed's 25th Annual Regional and Community Bankers Conference, she said she backed the Federal Open Market Committee's quarter-point hike in September and expects it will be appropriate to raise rates "a bit further" before the end of the year.49 She added that her view on whether to move, and when, will depend on how the full range of incoming data shapes her outlook.8

The data she described points in two directions. Core PCE inflation, measured on a three-month annualized basis, was running at only 2%, which is in line with the Fed's target.8 Even so, Collins expects headline and core inflation to climb back above 2% in the coming months. She pointed to the recent jump in prices for refined fuels such as jet fuel, diesel and home heating oil.89 She also said spending on artificial intelligence data centers is pushing up inflation readings, partly by raising the cost of building materials.16

On a 12-month basis the picture is less encouraging. Headline PCE inflation was 3.4% in August and core PCE was 3.0%. Both remain well above a target the Fed has now missed for about five and a half years.4 The August report itself came in cooler than economists expected. However, Bill Adams, chief US economist at Fifth Third Commercial Bank, said part of the improvement came from benchmark revisions to how inflation is measured rather than from a real change in the trend. He called the report a "glass half empty" for the Fed.3

This reading takes Collins at her word. She sees a mostly benign core trend that is being disrupted by two supply-side shocks, and she wants the policy rate somewhat higher to protect against those shocks spreading.

The breadth question

The key point in her remarks was a test she set out. Collins said the Fed needs to watch whether elevated inflation stays mostly confined to energy and AI-buildout categories while price growth keeps easing elsewhere, or whether price pressures start to broaden.68 In later comments she said uncertainty is elevated and that she is paying close attention to how widespread inflation pressures are.10

This matters for timing. Forecasters expect the September consumer price index to show the gap Collins described. Economists surveyed by Dow Jones expected headline CPI to rise 0.6% for the month and 3.6% from a year earlier, while core CPI was expected to rise only 0.2% for the month and 2.5% for the year.39 Several bank forecasters reached similar conclusions. Deutsche Bank projected a 9.6% seasonally adjusted rise in motor fuel prices alongside soft core inflation. Wells Fargo said underlying inflation looked contained despite swings in headline energy prices, a view it said fits with the Fed holding steady in October.27 Credit Agricole said the report would probably look mixed to the Fed.27

The coverage does not fully agree on how much risk there is. Bank of America economists expect energy-related second-round effects to stay fairly contained but see risks tilted slightly upward, including the chance of a second straight 0.3% monthly rise in core prices.44 RBC economists warned that a persistently firm core reading could put an October hike back under consideration.43 Consumer psychology adds to the concern. The New York Fed's September survey showed median one-year inflation expectations rising to 3.9%, the highest level since May 2023.21

Markets have moved from October to December

In recent weeks, expectations for the next hike have shifted from October to December. In late September, futures markets were close to evenly split on an October move, and some fixed-income traders were pricing back-to-back hikes at both remaining meetings this year.219 The cooler August PCE report changed that. CME FedWatch odds moved to about a 65% chance that the Fed holds in October.3 As of October 13, overnight index swap pricing showed a 66% probability of a hold at the October 28 meeting.14 Reporting citing LSEG data put the chance of an October hike at about 19%, with a quarter-point increase in December fully priced in.37

Collins's remarks fit this December consensus. Several Fed officials have recently suggested the next move will come in December rather than at the October 27–28 meeting.910 Her "before the end of the year" wording leaves her room to wait. September projections already showed one more increase this year, and 16 of 18 participants expected at least one further hike.15 On that basis, Collins looks more like part of the committee's center than an outlier, and her remarks matter mainly because they confirm that center rather than move it.

Forecasts beyond December vary more. JPMorgan's Michael Feroli expects one more hike in December, in line with the revised FOMC median.12 U.S. Bank's economists expect gradual tightening to continue into early 2027, adding a cumulative 75 basis points between October 2026 and March 2027 for a peak range of 4.25% to 4.50%.13 Not every voice agrees. New York Fed President John Williams was described as dovish because he supports one hike in 2026 and none in 2027.36

What it means for banks: margins up, loan demand at risk

The audience for the speech was community bankers, and Collins spent part of it on their balance sheets. She said loans with five-year rate terms are now repricing at higher rates. Along with new lending, that is bringing net interest margins at local banks back toward their post-financial-crisis averages.6 She also said the rates banks pay on interest-bearing accounts have stabilized after two years of increases, and that core deposit ratios have improved.6 Regional earnings have recovered from multi-year lows.4

There are limits. New England banks hold more of their assets in loans than peers elsewhere, especially residential mortgages on one- to four-family homes. Loan growth has slowed, although credit quality remains solid, with non-accrual loans below their long-term average.6 Collins said the region remains a highly competitive lending market and that community bank returns there still trail national peers, as they have for a long time.6 Merger activity has also slowed. The region has seen five bank mergers so far this year, compared with 15 in 2025.6

This is where the rate path becomes a real issue for banks. More tightening helps margins on floating-rate and repricing assets, but it raises costs for borrowers. After September's hike, the prime rate, which many banks use to price short-term business loans, stood at 7.00%. The effective federal funds rate was 3.88% and the discount window primary credit rate was 4.00%.16 Longer-term rates have risen even faster. The 10-year Treasury yield was around 5.2%, and Freddie Mac's 30-year fixed mortgage rate reached 7.4%, its highest level since November 2023, after seven straight weekly increases.1634

The large banks reporting this week reflected that tension. JPMorgan Chase missed consensus estimates for both earnings and revenue, partly because investment banking fees fell from the prior quarter. Goldman Sachs beat expectations by a wide margin.34 Schwab analysts warned that rising Treasury yields and the Fed's first hike in three years could weigh on loan demand.34 Fed Governor Christopher Waller said on the same day that higher yields are already curbing demand in rate-sensitive sectors. In effect, markets are doing some tightening on the Fed's behalf.34

The reading

Collins described the inflation data as mixed, but her policy conclusion is not mixed. She expects one more quarter-point hike, most likely in December, and wants proof that energy and AI costs are not spreading into broader inflation before she supports doing more.8910 Her baseline outlook is upbeat: healthy growth, a labor market near full employment, and productivity gains, including from early AI adoption, that help bring inflation down.6 She weighs two alternative scenarios almost as heavily. In one, AI investment overheats labor and asset markets. In the other, cost pressures build from the Middle East conflict and tariffs.4

For banks, this mix is about as good as it gets in the current environment. Funding costs have stabilized, older loans are repricing upward, and credit quality is holding. If the Fed stops after one more hike, margins should stay healthy. If core inflation broadens and the committee keeps going into 2027, as some bank economists expect, the gains on margins could be offset by weaker loan demand, with mortgage rates already above 7% and business borrowing priced off a 7% prime rate. The September CPI figures, and especially the core reading, are the next data point that will show which way that goes.