This analysis is by Bloomberg Intelligence analyst Dragos Ailoae. It appeared first on the Bloomberg Terminal. 

Bloomberg Barclays gauges finish strong 2016 despite rates surge
Despite surging rates after the unexpected U.S. election, high grade corporate bonds finished the best year since 2012, while high yield had the best year in seven, driven by tighter spreads especially in commodity sectors. U.S. high grade gained on an excess return basis in 4Q, with spreads tighter, especially at the long end of the curve. Spreads remain near long-term averages ahead of the Federal Reserve’s expected push for policy normalization, and spreads have historically been stable during Fed hiking cycles.

Tight spreads drive high grade returns to best year since 2012
The Bloomberg Barclays Global Aggregate Corporate bond index returned 4.27% in 2016 on an unhedged dollar basis, the best year since 2012. Tighter spreads boosted gains by 4.76% as the index OAS narrowed 33 bps, to an 18-month low of 124 bps on Dec. 27. The search for alternatives to low and negative yielding sovereign bonds drove demand, as the global Treasuries index yield (LGTRYW) reached 0.52% in July, lowest since its 2000 inception. Dollar strength hurt the non-dollar constituents, culling 1.5% of returns.

Flatter yield curves added 1.05% of gains in 2016 as the early-year rally in interest rates later overwhelmed a rising yield due to Donald Trump’s unexpected election victory, and higher inflation expectations stemming from potentially lax fiscal policies by the new administration.

Despite rising rates, corporate bonds gain on excess returns
Despite a decline in total returns for U.S. corporate bonds in recent months due to rising interest rates, excess returns — those exceeding U.S. Treasuries benchmarks — have on average stayed positive as credit spreads tightened. While the benchmark 10-year note’s yield climbed almost 60 bps since the November election to year-end, credit spreads tightened an average of 11 bps, as gauged by the Bloomberg Barclays U.S. Corporate Bond Index (LUACOAS).

Managing interest-rate risk gains importance as issuance has moved up the curve to longer maturities. The average high grade debt duration is more than seven years, as gauged by the Bloomberg Barclays U.S. Corporate Bond index, the longest since the index inception.

Long-dated bonds lead corporate spreads tighter as rates surge
The long end of the U.S. corporate investment grade yield curve flattened as rates rose following the U.S. elections, with the Bloomberg Barclays Long U.S. Corporate Bond Index (LD07OAS) spread to U.S. Treasury benchmarks narrowing 25 bps vs. 11 bps of tightening for the overall U.S. corporate index (LUACOAS). Long-duration bonds outperformed with an average 5.4% of excess returns for 10 years or longer bonds, which are 27% of the index market value. That’s compared with a 2.5% excess return for the overall index.