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Money Market Fund —
Money market returns remain at near-zero levels in 2014
4th Quarter, 2014
"While money market investors will likely endure another quarter of lackluster returns, there appears to be some light at the end of the tunnel. "
– Fischer Francis Trees & Watts, Inc.

Money market investments produced barely positive returns in 2014, as the Federal Reserve continued to hold its federal funds target rate at 0% to 0.25%, the range initially set by the Fed in December 2008. The BofA Merrill Lynch US 3-Month Treasury Bill Index, a proxy for money market performance, posted returns of 0.00% for the fourth quarter of 2014 and 0.03% for the full year.
The Harbor Money Market Fund slightly outperformed the index with returns of 0.01% for the fourth quarter and 0.06% for the 12 months ended December 31, 2014. Portfolio Manager Ken O'Donnell reports that the investment team has maintained a conservative strategy of investing exclusively in government and U.S. agency securities, which he believes provide the most value on a risk-adjusted basis in the current market environment. He notes that portfolio duration, as measured in average days to maturity, ended 2014 near the 40-day level, well within the statutory limit of 60 days.
Looking ahead, O'Donnell expects to see steepening in the front end of the money market yield curve in the months ahead as investors try to anticipate both the magnitude and pace of interest rate increases by the Federal Reserve. He believes that a strengthening U.S. economy should allow the Fed to begin raising short-term rates in the second half of 2015, although he notes that weak inflation could cause the central bank to delay tightening.
Ken O’Donnell’s comments were made in a January 20, 2015, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2014.

Interview Highlights

Monetary support
The challenge facing monetary policy makers in the next year is removing excess policy accommodation without derailing the recovery. The U.S. economy appears to be on firmer footing after a strong rebound in second and third quarter growth, and economists broadly expect growth to exceed 3% over the next year. However, the economy remains susceptible to destabilizing forces; specifically, a decline in global growth and persistent weak inflation levels in Europe could have negative implications for the U.S. That said, current levels of monetary policy stimulus remain accommodative and in our view should continue to support U.S. growth in the near-term.
Anticipated tightening
Money market yields should begin to price in the risk of a policy tightening as the year progresses. We expect the money market curve to steepen in the second quarter of 2015 as market anticipation builds ahead of an increase in the federal funds rate. This should result in improved returns in money market funds in the calendar year. While money market investors will likely endure another quarter of lackluster returns, there appears to be some light at the end of the tunnel.
Tracking inflation data
In our view monetary policy rates will remain anchored through mid-2015. We expect U.S. real GDP growth at roughly 3.5% and continued improvement in labor markets. With this backdrop, short-term U.S. Treasury yields should rise modestly from year-end levels, with intermediate yields continuing to trade directionally with economic data. Despite strengthening growth in labor indicators there is a risk that continued softening in inflation data could lengthen the Fed's current stance on policy accommodation, which likely would further depress yields in the belly of the yield curve.
U.S.-Europe divergence
Given the divergence between U.S. growth and European growth, we would not expect to see a significant relationship between what happens in Europe and what happens in the U.S. at present. If anything, we could see investors migrate from Europe into the U.S. as a result of very low European policy rates and what is perceived to be a very aggressive move by the European Central Bank to enter into quantitative easing, which we believe could depress yields for some time.

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