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Bond Fund —
Risk assets perform well despite geopolitical tensions and increased volatility
3rd Quarter, 2018
"The Fund's underweight positioning to duration reflects our belief in further rate increases and the tightening of monetary policy more broadly. "
– Pacific Investment Management Company LLC

Geopolitical developments – including escalating U.S.–China trade tensions, NAFTA negotiations, Brexit developments, Italian budget concerns, and turmoil in certain emerging market countries such as Turkey and Argentina – dominated news headlines and contributed to bouts of volatility in the third quarter of 2018. At the same time, several developed market central banks shifted toward reduced monetary accommodation. Nevertheless, risk assets performed well in the quarter. In particular, U.S. equities experienced gains as strong growth momentum helped to fuel positive investor sentiment.
The Harbor Bond Fund returned 0.24% during the third quarter, outperforming its benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index, which returned 0.02%. The Fund’s underweight position in longer maturity bonds contributed to relative performance, more than offsetting its overweight position in intermediate securities, which detracted from performance.
PIMCO’s comments were made in an October, 2018 report. Highlights adapted from the report appear below. All comments relate to the quarter ended September 30, 2018, unless otherwise indicated. All references to the year-to-date are for the period January 1 through September 30, 2018.

Interview Highlights

Economic Backdrop
No major changes to the Fund’s investment strategy were introduced in the third quarter. However, we reinforced our overall duration underweight position as we look to capitalize on higher yields in the U.S. The Fund’s underweight positioning to duration reflects our belief in further rate increases and the tightening of monetary policy more broadly. We believe the intermediate portion of the yield curve continues to offer attractive returns while longer term rates may rise as the Federal Reserve continues to reduce accommodation.
We Anticipate a Synchronized Deceleration of Growth
We believe world economic growth could slow somewhat in 2019 but remain above trend at 2.75% to 3.25%. With tighter global financial conditions, increased political and economic uncertainties, and U.S. fiscal stimulus starting to fade in 2019, we believe the economic divergence of 2018 – with the U.S. accelerating and other regions slowing – will give way to a more synchronized deceleration, with the U.S., eurozone and China all seeing lower growth next year compared to 2018. In the U.S., following an expansion of about 3% in 2018, we believe growth will slow to a below-consensus 2.0% to 2.5% range in 2019. This expected drop reflects our belief in less support from fiscal stimulus, the ongoing removal of monetary accommodation, a stronger U.S. Dollar, and a less favorable trade and external environment. With economic growth still above potential, however, we believe the U.S. unemployment rate could decline further. We believe inflation could peak at around 2.5% in response to tariff increases before moderating somewhat. We anticipate that three more increases in the federal funds rate are likely to happen by the end of 2019.
International Outlook
For the eurozone, we believe growth could decline to a range of 1.5% to 2.0% over the next year, down significantly from 2.5% in 2017 but still above potential. In our view, the European Central Bank could end its net asset purchases by the end of 2018, with a first interest rate increase more likely to happen than not in the second half of 2019. In the U.K., we believe real growth could accelerate to an above-consensus range of 1.5% to 2.0% in the next year based on our belief that Brexit negotiations could progress, avoiding a hard Brexit. This could help domestic demand in 2019. In our view, Japan’s Gross Domestic Product is likely to remain steady at 1.0% to 1.5% in 2019, supported by a tight labor market and accommodative fiscal stance. While we do not believe the Bank of Japan will raise interest rates, we anticipate further tapering of bond purchases and further steepening of the yield curve. In China, we believe 2019 growth will land roughly in the middle of a 5.5% to 6.5% range, reflecting large uncertainties caused by trade tensions with the U.S. and an economic policy with partially conflicting targets.

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