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Money Market Fund —
Monetary stimulus continues to weigh on money market returns
1st Quarter, 2014
"Investors have seen a very constrained opportunity set, where yields across all money market instruments are trending toward about the same range. "
– Fischer Francis Trees & Watts, Inc.

Yields generated by money market investments remained at historically low levels in the first quarter of 2014. The BofA Merrill Lynch US 3-Month Treasury Bill Index, a proxy for money market performance, recorded a return of one basis point, or 0.01%, for the three months ended March 31, 2014. The Harbor Money Market Fund closely tracked the index, with a return of 0.02% for the quarter. For the latest 12 months, the Fund and index each returned 0.07%, as the Federal Reserve maintained its 0.0% to 0.5% federal funds target rate, which has been in effect since December 2008.
Portfolio Manager Ken O’Donnell notes that a key challenge facing monetary policy makers is to gradually reduce stimulus measures without hurting the U.S. economic recovery. O'Donnell expects real GDP growth, which slowed to 2.6% in the fourth quarter, to average around 3% going forward.
Looking ahead, O’Donnell believes monetary policy rates are likely to remain anchored at least into early 2015. He expects yields of short-term U.S. Treasury notes to rise modestly from current levels, with intermediate yields trading in response to the latest economic data. In this environment, the Fund has maintained a moderate portfolio duration while continuing to invest only in U.S. government and agency securities.
Ken O’Donnell’s comments were made in an April 10, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2014.

Interview Highlights

Reducing stimulus
Recent volatility in intermediate interest rate markets, in our view, is largely in response to the recent shift in U.S. monetary policy tactics. The U.S. Federal Reserve has continued to reduce the pace of its monthly balance sheet purchases, or quantitative easing, at each meeting since the taper program was announced in December of last year.
Flat curve
We would not expect the money market curve to steepen prior to imminent changes in the federal funds rate, which we do not expect to occur until after balance sheet purchases have ceased. In the near-term, we think this financial repression in money markets will persist throughout 2014.
Narrow trading range
Most of the recent movement in the 3-year to 5-year part of the yield curve is in anticipation of a removal of policy accommodation, which we think is likely to occur in the time frame of 2015 and 2016. Holders of longer-term instruments will see the tail-end effects of policy rate tightening but money market investors won't. As a result, money market investors are not experiencing volatility in interest rate markets on the front end. In fact, 3-month to 12-month Treasury bills have been extremely stable, trading in a range of about one basis point throughout the year.
Limited opportunity
Investors have seen a very constrained opportunity set, where yields across all money market instruments are trending toward about the same range. This can change, particularly during periods of more active monetary policy. But at the moment we're not seeing a significant dispersion among money market funds in terms of the returns they're able to provide investors.
Yield spreads on commercial paper relative to U.S. agency discount notes have been reduced. As a result, from a risk/reward perspective, we think there is less incentive to invest in commercial paper relative to implicitly government-guaranteed instruments.

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.