As of 06-30-2018

Market Overview

The U.S. economic expansion continued in the second quarter of 2018, aided by consumer spending, increased capital investment and a lower trade deficit. The unemployment rate fell to a multi-decade low of 3.8% as a result of robust job growth. The under-employment rate, counting discouraged and involuntary part-time workers, also fell during the quarter. Companies continued to hold tightly to existing employees as new jobless claims remained exceptionally low. The recently enacted tax cuts, federal spending increases and lighter regulatory environment continued to drive a high level of confidence in the economic expansion from both corporations and consumers. However, heightened trade rhetoric is leading to increased concern among some businesses. The Federal Reserve’s (Fed) favored measure of inflation, core Personal Consumption Expenditure (PCE), continued to move higher and reached the Fed’s target of 2%. Fed Chair Jerome Powell stated that the members of the Federal Open Market Committee (FOMC) expect inflation to slowly rise in coming quarters, exceeding the Fed’s long-term target, but that the inflation target is symmetric, and the FOMC is unlikely to react abruptly to higher inflation since inflation has been significantly below target for nearly a decade. The FOMC raised the federal funds target rate to a range of 1.75-2% during its June meeting. The committee continued to reduce the size of the Fed’s balance sheet by gradually allowing a portion of its Treasury and mortgage-backed security (MBS) holdings to roll off without reinvestment over a period of years, subject to certain caps on the pace of the decline in holdings.

Interest rates rose across the curve, with larger increases at the short end and a smaller increase at the 10-year point. The S&P 500 rose during the quarter after a first quarter decline. Outside the U.S., the outlook moderated somewhat. Growth in Europe, Japan and emerging markets continued, though at a somewhat slower pace. The fiscal position of the U.S. government continued to be troublesome. Total U.S. Treasury debt outstanding is over $21 trillion, more than the entire gross domestic product (GDP) of the U.S.

Treasury rates rose during the period across the yield curve as the markets priced in more interest rate increases by the Fed. Mortgage securities outperformed similar-duration Treasuries.

As of June 30, 2018, the yield on 2-year Treasury securities rose 26 basis points to end the quarter at 2.53%, and the yield on 10-year Treasury securities rose 12 basis points to end the quarter at 2.86%.

Fund Performance

For the three months ended June 30, 2018, Federated Mortgage Fund (Institutional Shares) returned 0.16% versus 0.24% for the unmanaged Bloomberg Barclays U.S. Mortgage Backed Securities Index. The Institutional Shares’ net asset value (NAV) on June 30, 2018, was $9.33.

Performance data quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than what is stated. Other share classes may have experienced different returns than the share class presented. To view performance current to the most recent month-end and for after tax returns, click on the Performance tab.

Click the Performance tab for standard fund performance.

Duration management made a positive contribution to the fund’s performance as the fund maintained a below-neutral duration stance and yields rose during the period. The fund’s overweight to higher-coupon mortgages, relative to 3.5% and 4% mortgages, detracted slightly from fund performance as the lower-coupon mortgages performed well during the quarter. The fund’s sector allocation did not make a material contribution to fund performance during the quarter as the fund has reduced its out-of-index sector allocations.

Positioning and Strategy

The fund continues to keep a low allocation to non-government sectors as spreads have become very tight and we see less opportunity for outperformance. These sectors include non-agency-guaranteed MBS, non-agency-guaranteed commercial MBS and asset-backed securities. Within the government sector, the fund has a below neutral allocation to Ginnie Mae securities and an overweight to Fannie Mae and Freddie Mac mortgage securities. The fund ended the second quarter with a below-neutral duration stance.