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Money Market Fund —
Fund outperforms as monetary tightening returns
4th Quarter, 2016
"We believe that opportunities to improve relative portfolio performance are likely to increase in the coming year. "
– Fischer Francis Trees & Watts, Inc.

Government bond yields in most markets rose in the fourth quarter of 2016, as expectations shifted toward potentially higher growth and income, together with potentially less accommodative monetary policy. Global government yields climbed modestly from very low levels in the weeks leading up to the U.S. presidential election, and the trend continued after the victory of President Donald J. Trump. Markets entered a “risk-on” phase, with riskier assets outperforming sovereign debt.
In December, the Federal Open Market Committee (FOMC) of the U.S. Federal Reserve (Fed) raised its target for short-term interest rates by 25 basis points, to a range of 0.50% to 0.75%. It was the second time in 10 years that the Fed had raised rates, and the first since December, 2015. U.S. Treasury yields climbed back to prior year-end levels during the fourth quarter, with U.S. 10-year notes closing the year above 2.50%, up from 1.60% at the end of the third quarter, and significantly higher than the 2016 lows reached in late June.
Against this backdrop, the Harbor Money Market Fund returned 0.10% for the fourth quarter of 2016. The Fund outperformed the 0.08% return of its benchmark, the BofA Merrill Lynch US 3-Month Treasury Bill Index after fees. Portfolio returns benefited from excess yield associated with agency discount notes. Duration and yield curve positioning modestly contributed to performance. For the full year of 2016, the Fund returned 0.35%, which also outperformed the benchmark’s 0.33% return.
Comments by Fischer Francis Trees & Watts were made in a January, 2017 report. Highlights adapted from the report appear below. All comments relate to the quarter ended December 31, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through December 31, 2016.

Interview Highlights

December Rate Increase Was Expected; More in 2017?
Markets fully expected the tightening of Fed monetary policy at the December FOMC meeting. The corresponding Summary of Economic Projections forecasted an additional three increases in 2017. We believe market expectations for short-term interest rates have increased, though they remain below Fed forecasts. Further, we believe that interest rates are likely to be closely tied to the effective implementation of the new administration’s policies.
Inflation Expectations on the Rise
Inflation expectations increased significantly following the U.S. Presidential election. The Treasury Inflation-Protected Securities (TIPS) market is currently pricing in expectations for future inflation at roughly 2.00% for the next ten years. Survey-based measures remained low. The change in administration is expected to result in an increase in government spending and a decrease in corporate and individual tax rates, both of which are considered positive drivers of growth and inflation. However, we believe inflation expectations may be capped by a more active Federal Reserve as we migrate from monetary to fiscal stimulus.
Outlook Optimistic, but Tinged With Cynicism
While we became more optimistic in response to improving economic data, we were surprised by the abrupt shift in market sentiment following the U.S. Presidential election in November. We recognize that this surprise event may serve as the catalyst for “animal spirits,” a Keynesian term used to describe human emotion that drives consumer confidence, and renewed investment. However, we are generally cynical of the new administration’s ability to successfully implement campaign policy measures as quickly and efficiently as markets are expecting.

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