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Money Market Fund —
Money market returns remain at near-zero levels as Fed trims stimulus
2nd Quarter, 2014
"We are beginning to see light at the end of the tunnel in money market funds. "
– Fischer Francis Trees & Watts, Inc.

Money market investments continued to produce barely positive returns for the first half of 2014. The BofA Merrill Lynch US 3-Month Treasury Bill Index, a proxy for money market performance, registered returns of one basis point, or 0.01%, for the second quarter of 2014 and 0.02% for the six months ended June 30, 2014.
The Harbor Money Market Fund posted returns of 0.01% for the latest quarter and 0.03% for the first half of 2014, closely tracking the index. For the 12 months ended June 30, 2014, the Fund returned 0.06% while the index returned 0.05%.
The Federal Reserve continued to reduce monetary stimulus by scaling back its monthly bond purchases during the second quarter and is currently on pace to end the bond-buying program in the fourth quarter of 2014, notes Harbor Money Market Fund Portfolio Manager Ken O'Donnell. In terms of portfolio strategy, O'Donnell and his team continue to invest only in government and agency securities, which they believe provide the most value on a risk-adjusted basis.
Ken O’Donnell’s comments were made in a July 16, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended June 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through June 30, 2014.

Interview Highlights

Monetary tightening
In terms of the yield curve, short-term interest rates remained very low in response to the near-zero target federal funds rate. Two-year note yields, meanwhile, rose in expectation of a tightening of monetary policy in the coming year. Despite changes in intermediate yields, the money market curve, given its short tenure, remains relatively flat. We would not expect the money market curve to steepen prior to imminent changes in the fed funds rate, which is unlikely to occur until about mid-2015.
Fragile recovery
A plunge in real GDP growth in the first quarter created some concern that the recovery remains somewhat fragile. While a resumption of the 3% growth trend is expected for the rest of the year, the economy remains susceptible to destabilizing forces. It's important to recognize that even with tapering of quantitative easing, current levels of monetary policy remain accommodative and will continue to support the recovery in the near-term.
Current outlook
The foundation of our outlook is that monetary policy rates will remain anchored into 2015 with real GDP growth averaging around 3%. Short-term U.S. Treasury note yields will likely rise modestly from here with intermediate yields continuing to trade directionally with economic data. It remains possible that an unexpected improvement in economic conditions could shorten the current stance on policy accommodation and result in an increase in the term structure sooner than is anticipated by markets.
Draining reserves
Steps to begin draining excess reserves from the system will likely occur later this year and in the first quarter of 2015 before an announcement of any tightening cycles. That would have implications for short-term Treasurys and money market securities, which would likely see a benefit, a slight increase in rates, in advance of a tightening of policy. We believe that the best thing to do in this environment would be to keep duration relatively short to take advantage of higher yields as they become available.
Anticipating improvement
We are beginning to see light at the end of the tunnel in money market funds. It's been a long, slow grind to this point, where now we are anticipating higher yield levels in the coming 12 months. We believe it will be a gradual climb forward, enabling us to respond carefully. Back in May 2007, money market funds were yielding in excess of 5%, and it was a quick drop down to zero. I would expect that in the tail end of this upcoming tightening cycle, we could possibly see money market funds approaching the 3% level.

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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.

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