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Bond Fund —
Despite the uncertain political climate, equities rallied and credits tightened
2nd Quarter, 2017
"With policy normalization underway, we believe the Fed will embark on reducing its balance sheet by gradually tapering its reinvestments in a predictable and transparent manner. "
– Pacific Investment Management Company LLC

From key elections in France to political controversy in both the United States and Brazil, geopolitics dominated headlines during the second quarter of 2017 and contributed to brief periods of market volatility. Still, robust risk appetite continued, largely underpinned by a solid fundamental backdrop. Despite geopolitical uncertainty, volatility remained relatively low for the most part, equities rallied and credit spreads tightened. Emerging market assets broadly continued to strengthen despite falling oil prices (stemming from supply dynamics) and another U.S. Federal Reserve (Fed) rate hike.
The Harbor Bond Fund returned 1.62% during the second quarter, outgaining its benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index, which returned 1.45%. Contributors to relative return included the Fund’s U.S. interest rate strategies and an out-of-benchmark allocation to non-agency mortgage-backed securities. The Fund’s underweight positioning in investment grade bonds and an out-of-benchmark allocation to Treasury Inflation-Protected Securities (TIPS) hindered relative returns.
PIMCO’s comments were made in a July, 2017 report. Highlights adapted from the report appear below. All comments relate to the quarter ended June 30, 2017, unless otherwise indicated. All references to the year-to-date are for the period January 1 through June 30, 2017.

Interview Highlights

Monetary Policy in the U.S. and Elsewhere
Financial conditions in the U.S. eased even as the Fed raised rates and unveiled details of its plan to gradually reduce its balance sheet. The Fed’s actions contributed to a flattening in the U.S. yield curve. On the back of falling oil prices, soft inflation data and waning prospects for fiscal stimulus, inflation expectations dropped to pre-U.S. election levels. Longer term U.S. yields also fell on the quarter. Global central bankers struck a less accommodative tone: rhetoric from the European Central Bank, the Bank of England and the Bank of Canada highlighted positive economic outlooks and suggested the potential for a reduction in easy monetary policy. In turn, most developed market yields rose higher even as those in the U.S. (outside the front end) fell.
We Believe the Economic Expansion Could Continue
We believe the eight-year-old global economic expansion could strengthen and broaden for the remainder of 2017. We maintain our view from last quarter that global Gross Domestic Product (GDP) growth could reach the 2.75%-3.25% range this year, up from 2.6% in 2016, while consumer price index (CPI) inflation could reach 2.0%-2.5%. Our outlook reflects several factors that we consider encouraging, including generally supportive fiscal policies (or expectations of them) in most developed market economies and improved consumer and business confidence data. In the U.S., we believe GDP growth could reach 2%-2.5% in 2017 should business investment recover, particularly in the Energy sector. Our forecast anticipates that core inflation could hover sideways this year at 1.75%-2.25%, owing to some softer trends of late. With policy normalization underway, we believe the Fed will embark on reducing its balance sheet by gradually tapering its reinvestments in a predictable and transparent manner.
International Outlook
For the eurozone, we now believe that growth could rise to a range of 1.75%-2.25% in 2017, revised higher from our forecast in March to reflect what we view as stronger momentum since then. While political uncertainty remains ahead of elections in Germany and potentially Italy, the likelihood of disruptive populist outcomes has diminished, in our view. In addition, both fiscal and monetary policy are expansionary, and we believe the recovery in global trade growth supports exports and investment. In the U.K., we expect growth could stay in the range of 1.5%-2.0% despite Brexit, reflecting robust momentum, higher government spending and a positive contribution from net trade on the back of the 15% drop in the Pound in 2016. We believe that Japan’s strong private demand and export growth could support GDP growth of 1.0%-1.5% in 2017, with inflation likely remaining significantly below the 2% target. Turning to emerging markets, we believe that China could achieve growth in a 6.25%-6.75% range in 2017 if policy makers prioritize financial stability over economic stimulus ahead of the 19th National Party Congress in the fourth quarter. We believe Brazil and Russia could experience moderate growth in 2017 as they emerge from recession. With inflation dropping, both countries’ central banks have room to cut rates further.

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