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Bond bonanza boosts Wall Street and beyond...and it’s likely to continue

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The third-quarter earnings season has proven to be largely positive for banks, mostly due to their fixed income trading bolstering their balance sheets.

JPMorgan beat analyst expectations this month, announcing fixed income revenues were up 48 percent on the year. Goldman Sachs crushed estimates, reporting that its fixed income, currency and commodities trading was the main driver, increasing 34 percent on year.

The same happened for Citigroup and Bank of America and European lenders, such as Barclays, have followed suit. And this trend could be set to continue, according to Jane Foley, head of FX strategy at Rabobank.

"It is possible that banks' profits will continue to be supported by fixed income. The increase in volatility may support the number of transactions and could lead to higher profitability for banks," she told CNBC.

Foley defends that political uncertainty in 2017 will lead to more volatility in bond markets. The uncertainty regarding the U.S. election might soon evaporate, but Europe faces key elections – including in Germany, France and the Netherlands, where rising support for nationalist parties is becoming stronger.

Janet Yellen
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Janet Yellen

Expectations that the U.S. Federal Reserve will again raise interest rates and potential changes to global inflation might also increase the odds of market volatility. This comes after bonds, which are perceived as a safe haven, have once again been back in favor this year with the German government bund yield falling below zero a few months ago. Yields move inversely to bond prices.

"Fixed income trading will continue to drive investment bank profitability (into 2017), as the new bond issuance calendar looks strong. M&A (merger and acquisition)-related issuance as well as corporates extending their debt maturity profile seems like it will continue, especially ahead of further U.S. interest rate increases," Shilen Shah, a bond strategist at Investec, told CNBC.

Fed officials have given indications that a second rate hike this year could take place in December. However, in Europe, there are no interest hikes on the horizon, with the ECB (European Central Bank) expected to keep its monetary policy loose.

"Divergence (in) interest rate policy could potentially be a catalyst for more volatility in bond markets," Shah said.

"If inflation expectations increase, driven for example by a higher oil price, some of the deflationary pressures on bond yields could be reserved. Increased bond market volatility is most likely to benefit those banks with large fixed-income flow businesses, as they are likely to see higher trading volume."