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Core Bond Fund —
The Federal Reserve raised interest rates during the third quarter
3rd Quarter, 2018
"We believe it is important to continue to lean on our security selection skills and actively manage portfolio risk. "
– Income Research + Management

The ongoing trade war with China, which sustained another round of tariffs in late September, has had little visible effect on the U.S. economy. The U.S. unemployment rate remained solid at 3.9%, and the Consumer Price Index increased 2.7% over the last 12 months. Gross Domestic Product growth estimates for the third quarter of 2018 hovered around 4.1%. At its September meeting, the Federal Reserve (Fed) raised interest rates, boosting the federal funds target rate to 2.00%-2.25%—the highest since October 2008. This rate hike was the third so far in 2018 and the eighth since December 2015, which started the current hiking cycle.
In this environment, the Harbor Core Bond Fund (Institutional Class) returned 0.07% during the third quarter, and outperformed its benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index, which returned 0.02%. An underweight position in treasuries and an overweight position in corporate securities, namely in the Financials and Industrials sectors, contributed to relative performance. In the securitized sector, an overweight position in commercial mortgage-backed securities (MBS) and an underweight in agency MBS also benefited relative results. Detractors from relative performance included security selection Financials and Industrials, as well as in commercial MBS. Out-of-benchmark exposure to U.S. Small Business Administration securities also hindered relative results.
IR+M’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

Treasury Yields Increased Across the Yield Curve
Based on market-implied probabilities, there is a 70% chance that the Fed will raise interest rates in December 2018. In its most recent statement, the Fed again cited the continued strengthening of the labor market and solid economic activity. Job gains have remained robust, and unemployment has been persistently low. Treasury yields increased across the yield curve, with the 10-year yield rising 20 basis points to end the quarter at 3.06%, and the five-year yield reaching a post-crisis peak of 2.98% before retreating to 2.95% at the end of the quarter. The gap between two-year and 10-year treasury yields at quarter-end—at 0.24%—was close to its narrowest in more than a decade.
Predicting the Timing, Direction and Magnitude of Future Interest Rate Changes Is Difficult
We believe that predicting the timing, direction and magnitude of future interest rate changes is difficult to consistently get right. With this in mind, we do not maintain an outlook on interest rates. We remain committed to our disciplined, bottom-up approach while keeping the Fund duration-neutral relative to its benchmark and actively managing portfolio risk. Allocation shifts were made on the margin during the quarter, as we took advantage of long corporate spread widening in early July and participated in what we viewed as attractive new issues.
The U.S. Economic Outlook Remains Strong
Entering the fourth quarter, we believe the U.S. economic outlook remains strong, supported by a robust labor market that is driving consumer spending. The core inflation rate continues to hover around the Fed’s 2% inflation rate target. The potential for an inverted yield curve still exists, in our view, but that may not deter the Fed from future tightening. The consensus view is that the Fed will raise rates again in December 2018 and three additional times in 2019. While the new Chinese tariffs have yet to significantly affect the U.S. economy, we believe the Fed could suspend its rate hikes if trade wars remain a concern.
Recent Comments Point to Continued Monetary Policy Tightening
Recent comments made by the Fed, in addition to current market-implied probabilities, point to continued tightening of monetary policy. Historically, corporate spreads and treasury yields have moved in opposite directions. If rates continue to rise, we believe corporate spreads could grind tighter from their already historically tight level. Given this backdrop, we believe it is important to continue to lean on our security selection skills and actively manage portfolio risk.

Performance data shown represents past performance, which is no guarantee of future results. Current performance may be higher or lower than the past performance data shown. Investment returns and the value of an investment will fluctuate, and an investor's shares, when sold, may be worth more or less than their original cost. You can obtain performance data current to the most recent month-end (available within seven business days after the most recent month-end) by calling 800-422-1050 or visiting

Performance figures discussed reflect that of the institutional class shares.

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.

This information should not be considered as a recommendation to purchase or sell a particular security and the holdings or sectors mentioned may change at any time and may not represent current or future investments.