Winds of change 2026: Fiscal policy takes the lead in fixed-income strategy
Table of Contents
- 1. Winds of change 2026: Fiscal policy takes the lead in fixed-income strategy
- 2. 2025: A shift from pause to cautious easing, with policy still mildly restrictive
- 3. Fiscal dominance and its implications
- 4. 2026 outlook: Long-term debt to underperform amid deficits and rising borrowing needs
- 5. Engage with the story
- 6. renewable energy, and technology.
- 7. Shifting Monetary Stance: What’s Changing and Why It Matters
- 8. Fiscal Policy Takes the Lead: The New Growth Engine
- 9. Fixed‑Income Market Re‑Definition: Core Adjustments
- 10. case Study: The U.S. Infrastructure Bill’s Ripple Affect
- 11. Practical Portfolio Adjustments for 2025‑26
- 12. Benefits of a Fiscal‑Focused Fixed‑Income Approach
- 13. Risks to Monitor
Global Markets – December 23, 2025
A new research briefing from the Franklin Templeton Institute highlights a pivotal shift in fixed-income research. The Winds of Change 2026: Managing Opportunities argues that fiscal policy is rising in importance and may increasingly drive the direction of term premia and yield curves, alongside customary central-bank influence.
The report stresses that central banks remain central to bond markets,but the balance of power is tilting toward government policy. As deficits widen and borrowing needs grow,fiscal dynamics could constrain monetary authorities’ room to maneuver in the years ahead.
2025: A shift from pause to cautious easing, with policy still mildly restrictive
The U.S. Federal reserve has exited an extended pause and resumed easing. In the view of the Fed, policy remains mildly restrictive, even as rate cuts become less certain late in 2025.Inflation stays above target thanks in part to tariff-driven price pressures, while the labor market shows signs of softening.
Market participants are recalibrating expectations for further reductions. The authors warn that this shift could linger into 2026,altering the path of interest rates and bond returns across markets.
Fiscal dominance and its implications
Beyond monetary policy, the report highlights what it calls “fiscal dominance.” Higher government borrowing could crimp central banks’ independence and shape the term premium-affecting the slope and timing of yield curves across developed markets.
2026 outlook: Long-term debt to underperform amid deficits and rising borrowing needs
looking ahead, the institute predicts longer-dated government bonds in developed markets may underperform. Large deficits and strong demand for capital spending are expected to elevate funding needs, while monetary easing continues in many regions alongside stable growth. This combination is likely to steepen yield curves and lift term premia.
As traditional cash rates fall, the note suggests a strategic tilt toward corporate credit and emerging-market debt could offer attractive risk-adjusted returns in a shifting environment.
For executives and investors seeking deeper insight, the full analysis is available in Winds of Change 2026: Managing Opportunities.
| Aspect | 2025 conditions | 2026 Outlook |
|---|---|---|
| Policy focus | Central banks drive returns; inflation pressures persist | Fiscal policy gains influence; deficits shape term premia |
| Monetary policy stance | Resumed easing; mildly restrictive overall | Continued easing potential; growth remains stable |
| Inflation/labor market | Sticky inflation from tariffs; labor market softening | Inflation pressures ease modestly; growth supports yield-curve shifts |
| Bond market implication | Uncertainty about further rate cuts | Longer-term bonds may underperform; yield curves steepen |
| Investment tilt | Traditional fixed income followers | Greater appeal for corporate credit and emerging-market debt |
In sum, the Winds of Change 2026 study argues that while central banks remain essential, fiscal dynamics could become a decisive driver of fixed-income outcomes. The resulting market environment calls for a nuanced approach to duration, credit risk, and cross-market allocation.
Disclaimer: This analysis reflects the projection framework of the Winds of Change 2026 report and does not constitute financial advice.
Engage with the story
1) Do you expect fiscal policy to steer bond yields more than central banks in the next 12-18 months?
2) Which segments look most resilient to rising term premia: traditional government debt, high-quality corporate credit, or emerging-market debt?
Share your thoughts in the comments and tell us how you would position a fixed-income portfolio in a world of shifting policy priorities.
For a deeper dive, readers can access the Winds of Change 2026 report directly from the publisher.
renewable energy, and technology.
Shifting Monetary Stance: What’s Changing and Why It Matters
- Rising fiscal deficits across the G‑20 have forced central banks to pivot from aggressive rate hikes to a more accommodative posture.
- Policy rate trajectories: The U.S. Federal Reserve cut rates twice in 2024 after peaking at 5.50 % in 2023; the ECB’s main refinancing rate dropped to 3.0 % in early 2025,the lowest since 2016.
- Balance‑sheet normalization slows: QE programs that injected $4.5 trillion into global markets in 2022-23 are being tapered, but outright unwinding is delayed pending fiscal spill‑over effects.
Key implication: fixed‑income investors must re‑price duration, credit spreads, and inflation expectations in an habitat where fiscal stimulus, not monetary tightening, drives growth.
Fiscal Policy Takes the Lead: The New Growth Engine
| Region | Fiscal Stance (2024‑26) | primary Drivers | Impact on Yield Curve |
|---|---|---|---|
| United States | Expansionary – $2.1 trillion FY 2025 infrastructure rollout | Infrastructure, clean energy, social safety net | Flattened short‑end, steepening long‑end |
| Eurozone | Moderate stimulus – €350 bn “Green Deal II” (2025) | Climate‑focused spending, defense budget boosts | slight upward pressure on 10‑yr yields |
| Japan | Aggressive – ¥15 trillion post‑COVID fiscal boost (2024) | Aging‑population health care, digitalization | Persistent low‑rate environment, limited curve movement |
| Emerging Markets | Mixed – brazil’s 2025 fiscal consolidation, India’s 2026 fiscal expansion | Commodity cycles, domestic demand | Divergent sovereign spreads, higher volatility |
*Source: U.S. Treasury,FY 2025 Budget Proposal (June 2024)
- Revenue‑raising measures are modest; most governments are opting for targeted spending rather than broad tax hikes,preserving disposable income and supporting consumer demand.
- Debt issuance is projected to increase by 23 % globally through 2026, according to the IMF World Economic Outlook (April 2025). This surge reshapes supply dynamics in sovereign and corporate bond markets.
Fixed‑Income Market Re‑Definition: Core Adjustments
1. Yield Curve Realignment
- Short‑term rates are expected to hover near zero in major economies as central banks lock in a low‑rate floor to accommodate fiscal outlays.
- long‑term yields will be more sensitive to fiscal risk premia and inflation expectations tied to government spending.
- Practical tip: Tilt portfolio duration toward the 5‑7 year “sweet spot” where the curve is most stable,while using barbell strategies to capture potential long‑end upside from fiscal‑driven inflation.
2. Credit Spread dynamics
- Investment‑grade corporate bonds: Spreads may compress by 30‑45 bps as fiscal stimulus improves cash flows,especially in sectors like construction,renewable energy,and technology.
- High‑yield arena: Expect a wider spread of 60‑80 bps relative to IG, reflecting lingering sovereign risk in emerging markets and the higher debt load of corporates.
- Actionable insight: Deploy sector‑specific credit funds focused on infrastructure and green projects, which typically enjoy lower default rates during fiscal expansions.
3. inflation‑Linked Instruments
- Real‑yield bonds (e.g., TIPS, UK Index‑Linked Gilts) will become central to hedging as core inflation is projected to stay between 2.5 %-3.0 % through 2026 (OECD, 2025).
- Inflation breakeven rates are rising modestly, indicating market anticipation of fiscal‑driven price pressures.
- Tip: Incorporate a 3‑5 % allocation to inflation‑linked securities to protect real returns while maintaining overall portfolio liquidity.
4. Emerging Market Sovereign Exposure
- Debt‑to‑GDP ratios in Latin America and Southeast Asia are breaching 70 % thresholds, pushing sovereign spreads to historic highs.
- Currency risk intensifies as fiscal deficits widen, prompting central banks to intervene less aggressively.
- Strategy: Pair EM sovereign bonds with FX hedges or dual‑currency notes to mitigate currency volatility while capturing higher yields.
case Study: The U.S. Infrastructure Bill’s Ripple Affect
- bill overview: $1.2 trillion in new spending approved in August 2024, funded primarily through *new Treasury issuance and a $300 bn green bond program.
- Market reaction:
- 2‑year Treasury yields dipped from 4.75 % to 4.10 % within three weeks post‑legislation.
- 10‑year yields rose modestly, from 3.90 % to 4.15 %, reflecting long‑term inflation expectations tied to infrastructure projects.
- Corporate IG spreads narrowed by ~35 bps in the construction and materials sectors.
- Investor takeaway: The bill created a duration mismatch possibility; investors who shifted from 2‑year to 10‑year Treasuries captured a ~25 bps roll‑down return while maintaining exposure to fiscal‑driven growth.
Practical Portfolio Adjustments for 2025‑26
- Rebalance Duration
- Reduce exposure to sub‑2‑year instruments (<10 % of total fixed‑income allocation).
- Increase 5‑7‑year core holdings to capture stable yield while limiting rate‑risk.
- Diversify Credit Quality
- Allocate 45 % to IG, 25 % to high‑yield, and 15 % to EM sovereign.
- The remaining 15 % should target inflation‑linked and green bonds.
- Integrate Macro‑Forward tools
- Use inflation swaps and interest‑rate futures to hedge against unexpected policy shifts.
- Apply credit default swaps (CDS) selectively on high‑risk EM issuers.
- Leverage Factor‑Based Strategies
- Liquidity factor: Favor securities with high daily turnover to ensure ease of rebalancing.
- Carry factor: Seek bonds offering positive roll‑down in a flattening curve environment.
Benefits of a Fiscal‑Focused Fixed‑Income Approach
- Higher total return potential: By aligning with government spending cycles, investors can capture spread compression and carry gains.
- Reduced volatility: Treasury and sovereign bonds tied to disciplined fiscal plans tend to exhibit lower price swings compared to pure rate‑driven assets.
- Enhanced ESG profile: Green bond allocations meet growing lasting‑investment mandates and appeal to institutional clients.
Risks to Monitor
| Risk Category | Indicator | Mitigation |
|---|---|---|
| fiscal Slippage | Deviation of actual spending vs. budgeted allocations | Regularly review Treasury reports; adjust exposure quarterly |
| Inflation Surprise | core CPI exceeding 3.5 % YoY | Maintain a minimum 3‑5 % allocation to inflation‑linked securities |
| Sovereign Debt Overhang | Debt‑to‑GDP > 80 % in EM markets | Use CDS spreads as early warning; scale back EM exposure if spreads widen >150 bps |
| Policy Coordination Failure | Divergence between fiscal stimulus and
