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Bond Fund —
Markets remained resilient among geopolitical shocks
3rd Quarter, 2016
"We believe global growth could pick up slightly from around 2.5% this year to between 2.5% and 3.0% in 2017, and believe that inflation will remain below target in most major developed market economies. "
– Pacific Investment Management Company LLC

During the third quarter of 2016, markets generally shook off the surprise Brexit result as equities rallied and volatility remained low, despite building concerns over the future path of monetary policy globally. Markets remained relatively resilient despite a host of geopolitical shocks, including new leadership in the United Kingdom and Brazil, an attempted coup in Turkey and an increasingly contentious presidential race in the United States. Volatility generally remained below long-term averages, U.S. equities set new all time highs, credit spreads tightened and emerging market assets performed well in the seemingly benign market environment.
The Harbor Bond Fund returned 1.37% during the quarter, outgaining its benchmark, the Barclays U.S. Aggregate Bond Index, which returned 0.46%. Contributors to relative return included out-of-benchmark allocations to Treasury Inflation-Protected Securities, high yield bonds and non-agency mortgage-backed securities. Detractors from relative performance included an underweight allocation to investment grade bonds and local interest rate exposure in Mexico.
PIMCO’s comments were made in an October, 2016 report. Highlights adapted from the report appear below. All comments relate to the quarter ended September 30, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through September 30, 2016.

Interview Highlights


Economic Backdrop
Central banks held the spotlight as concerns over the longevity of central bank support grew amidst the uneasy market calm. The Bank of Japan’s “comprehensive review” led to a shift in framework from base-money targeting to yield curve targeting with an intent to steepen the curve, which was welcome news to Japanese banking and insurance stocks that had been under pressure from negative interest rate policy. A largely unchanged and tepid fundamental backdrop did little to dampen risk sentiment. A soft patch in U.S. growth in the first half of 2016 was tempered by continued improvement in labor market gains and U.S. consumer spending. In Europe, both the U.K. and eurozone showed signs of resiliency post-Brexit as business and consumer sentiment rebounded after initial data suggested a darker outlook.
Changes to Positioning
We reduced the Fund’s local rate exposure in Mexico, as we expect the Mexican central bank to hike rates in parallel with the United States in response to normalization of U.S. monetary policy. We also decreased Italian rate exposure, because the Italian economy is undergoing a fragile recovery on the back of a weaker Euro, looser financial conditions and an upcoming reform referendum. We are cautious when investing in European assets over the medium-term. Our secular investment focus on capital preservation is especially relevant for the region, where the macro outlook is underwhelming, political risk is elevated and compensation for that risk is slim. Based on recent market moves, we reduced the portfolio’s net currency exposure. We continue to expect divergence between the Fed and other central banks, including the Bank of Japan and the European Central Bank. While we believe this policy divergence will nudge the Dollar higher, we recognize the impact may be more limited given the extent of Dollar appreciation over the past 18 months.
Expectations of Increased Growth
We believe global growth could pick up slightly from around 2.5% this year to between 2.5% and 3.0% in 2017, and believe that inflation will remain below target in most major developed market economies. In the U.S., we believe growth may return to between 2% and 2.5% in 2017, following the soft patch earlier this year. We expect an end to the inventory correction and a revival of business investment amid robust consumer spending. We anticipate a rise in headline consumer price index inflation to a range of 2% to 2.5% next year, which would likely allow a data-dependent Federal Reserve to raise interest rates two or three times between now and year-end 2017.
Our baseline forecast is for a continuous global expansion, mostly supportive monetary and fiscal policies and broadly range-bound markets. However, we are concerned about risks that lurk beneath the surface, especially with asset prices that in many cases appear stretched. We expect that periods of relative calm in the markets are likely to be punctuated by bouts of volatility and uncertainty brought on by the “cause” of the moment.

Performance data shown represents past performance, which is no guarantee of future results. Current performance may be higher or lower than the past performance data shown. Investment returns and the value of an investment will fluctuate, and an investor's shares, when sold, may be worth more or less than their original cost. You can obtain performance data current to the most recent month-end (available within seven business days after the most recent month-end) by calling 800-422-1050 or visiting www.harborfunds.com.

Performance figures discussed reflect that of the institutional class shares.

The views expressed herein are those of the portfolio manager at the time of the interview and may not be reflective of their current opinions or future actions.  These views are not necessarily those of the fund company and should not be construed as such.

This information should not be considered as a recommendation to purchase or sell a particular security and the holdings or sectors mentioned may change at any time and may not represent current or future investments.