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Money Market Fund —
Policymakers recently adopted a more dovish tone
2nd Quarter, 2016
"Global fixed income markets recovered from first quarter market turbulence in the early part of the quarter before turning attention to Brexit worries in June. "
– Fischer Francis Trees & Watts, Inc.

U.S. markets traded in a defined range during the second quarter of 2016 before succumbing to global pressures following the Brexit vote. Expectations for potential tightening of U.S. monetary policy faded quickly after the release of a weak May employment report. Policymakers adopted a more dovish tone in response to both softer U.S. economic data and the return of global turmoil. The U.S. 10-year Treasury note yield ended the quarter at 1.50%, close to historical lows.
Against this backdrop, the Harbor Money Market Fund returned 0.07% for the quarter. The return matched the return of its benchmark, the BofA Merrill Lynch US 3-Month Treasury Bill Index.
Fischer Francis Trees & Watts' comments were made in a July, 2016 report. Highlights adapted from the report appear below. All comments relate to the quarter ended June 30, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through June 30, 2016.

Interview Highlights

Global Yields Declined to Record Lows
Global fixed income markets recovered from first quarter market turbulence in the early part of the quarter before focusing on Brexit worries in June. The referendum outcome to leave the European Union surprised investors, who had largely dismissed the risk in the days before the vote. Global yields declined to record lows at the end of the quarter in a pronounced flight to quality in response to increased risk aversion.
Monetary Policy
Our expectations for the pace of monetary policy tightening have declined significantly along with the markets, as the Fed has acknowledged that exogenous factors play a more important role in the reaction function than in the past. The U.S. appears less able to decouple from challenges around the globe in the increasingly global economic environment. It now appears unlikely that the Fed will be able to avoid the negative feedback loops associated with divergent monetary policy (e.g., Fed tightening and easing by the Bank of Japan and European Central Bank). We believe that U.S. interest rates are likely to remain lower for longer in this protracted recovery.
Durations Extended Modestly
The Fund’s absolute performance was in line with the prior quarter. Year-to-date performance improved over the prior year in response to monetary policy tightening in December of 2015. Short-term yields quickly adjusted to rising policy rates, though expectations for further increases have recently declined in response to softer economic data and global market turmoil. We modestly extended portfolio durations to capture excess yield embedded in the short end of the government yield curve. Otherwise, there were few changes to the portfolio during the quarter. Portfolio returns benefited from excess yield associated with agency discount notes. Duration and yield curve positioning modestly contributed to performance as well. No single position detracted from performance in the quarter.
Growth and Inflation Expectations
We became more pessimistic, on the margin, during the quarter in response to softer economic data and elevated populist political risk around the globe. Significant improvement in economic data would be required to reverse this shift in sentiment. The global economic environment has become increasingly unsettled, limiting the ability of the U.S. economy to successfully decouple and return to a self-sustaining growth path. We recognize that neutral policy rates are likely much lower than in the past, and that the U.S. growth trend has probably declined to 1.8%. While we believe that the economy will likely exceed trend growth in the coming year, we consider a return to 3% growth rates in the near-term unlikely. Our expectations for U.S. inflation were unchanged during the quarter. We continue to expect a modest drift toward the 2% target over a protracted period of time. This view depends largely on the emergence of wage pressures from a continually tightening labor sector. We anticipate that the Fed will be more patient in removing policy accommodation in the coming months. The pendulum of sentiment has shifted considerably in recent weeks, and we would not be surprised if the Brexit impact fades and improving data reignite Fed tightening discussions, to some degree, in the third quarter.

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