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Franklin Templeton Institute’s latest Winds of change paper explores how shifts in monetary and fiscal policy are reshaping fixed income markets.

Central banks remain pivotal actors, and monetary policy is expected to impact bond returns across all fixed income markets. However, Franklin Templeton analysts argue that fiscal policy is gaining importance and may play a key role in the direction of term premiums and the shape of yield curves.

In 2025, the US Federal Reserve transitioned from an extended policy pause to a resumption of easing. By the Fed’s own admission, US monetary policy remains mildly restrictive. Yet, as 2025 draws to a close, the Fed faces both above-target, sticky inflation due to tariff price increases and a softening labour market.

As a result, both the Fed and investors have become less certain about the prospects for further rate cuts. “That’s quite a big shift, and uncertainty seems likely to linger into 2026,” Franklin Templeton writes. Furthermore, ‘fiscal dominance’ may translate to elevated government borrowing needs constraining central banks’ ability to conduct independent monetary policies.

In 2026, Franklin Templeton predicts that longer-term government bonds in developed markets will underperform, given large budget deficits and strong borrowing demand for capital expenditures. Monetary easing, stable growth and rising term premia will likely underpin a steepening of yield curves.

As cash rates fall, Franklin Templeton analysts believe investors will turn to opportunities in corporate credit and emerging markets.