Western Asset Premier Bond Fund : Fixed Income Market Commentary

2Q 2022

Investment Highlights

Western Asset Fixed-Income Market

Key Takeaways

• Risk assets were significantly weaker and bond yields ended the quarter higher, but well off of their mid-June highs, as the market digested higher-than-expected inflation prints, a progressively more hawkish Fed and growing recession fears.
• The FOMC hiked the fed funds rate by 50 bps in its May meeting-its largest rate increase since 2000-and by 75 bps in its June meeting-its largest rate increase since 1994-to end the quarter at 1.50%-1.75%.
• US GDP unexpectedly contracted during the first quarter of 2022 at a revised annualized rate of -1.6%, while some US economic indicators showed further signs of cooling over the second quarter, including measures for consumer sentiment and housing activity.

Market Review

During the second quarter of 2022, risk assets were significantly weaker and bond yields ended the quarter higher, but well off of their mid-June highs, as the market digested higher-than-expected inflation prints, a progressively more hawkish Federal Reserve (Fed) and growing recession fears. WTI oil prices rose slightly, the S&P 500 was down over 16% and credit spreads were materially wider.

US inflation remained elevated during the quarter, with both broad and core measures printing above consensus expectations in May. The headline Consumer Price Index (CPI) accelerated from 8.3% year-over- year (YoY) in March to 8.6% in May-a40-year high. Energy prices rose nearly 4% on the month and have risen over 34% over the past year, with gasoline prices having risen nearly 12% YoY. Although May core CPI-excluding volatile food and energy components-decelerated from a cyclical peak of 6.5% in March to 6.0% YoY, this deceleration was at a somewhat slower-than-expected pace with the month-over-month (MoM) growth of 0.6% matching the previous month. In spite of consensus expectations that YoY inflation could begin to peak-mainly due to statistical base effects-recent inflation prints showed that the pace of decline may be bumpy and uneven.

The string of higher-than-expected inflation reports coupled with the desire of Fed officials to appear vigilant with respect to containing inflation led the Federal Open Market Committee (FOMC) to hike the fed funds rate by a total of 125 bps during the second quarter. As had been priced-in, the FOMC hiked by 50 bps in its May 3-4meeting-its largest rate increase since 2000-and by 75 bps in its June 14-15meeting-its largest rate increase since 1994-to end the quarter at 1.50%-1.75%. The May CPI print caught the Fed's attention, as did increased long-term inflation expectations. The Fed also released its June Summary of Economic Projections (SEP), which showed some significant changes from its March projections. 2022 US GDP growth was revised down to 1.7% from 2.8%, headline Personal Consumption Expenditures (PCE) inflation was revised up to 5.2% from 4.3% while core PCE inflation increased slightly to 4.3% from 4.1%. The projected year-end unemployment rate inched higher to 3.7% (from 3.5% in March). The Fed's dot plot also shifted significantly higher (again) from its March projections. The median FOMC member

now expects that it will be appropriate to hike the fed funds rate by an additional 165 bps this year to 3.40%, from 1.90% in March, and another 40 bps in 2023 to 3.80%, up from 2.80%. The longer-run projection for the fed funds rate-which many consider to be a reasonable estimate for the neutral policy rate-inched higher to 2.50% from 2.40% in March.

US GDP unexpectedly contracted during the first quarter of 2022 at a revised annualized rate of -1.6% (against an initial estimate of -1.4%), versus consensus forecasts for 1.0% growth, and a slowdown against 2021 full- year growth of 5.7% YoY. The contraction-the first since the COVID-19 recession during the first half of 2020-was mainly due to decreases in inventory purchases as well as a jump in imported goods. However, the downward revision to 1Q growth also contained substantive declines in demand components which appear to be continuing into 2Q and could lead to another weak GDP print.

With the exception of the strong jobs data, some US economic indicators showed further signs of cooling over the second quarter, including measures for consumer sentiment and housing activity. US employment was the main exception as nonfarm payrolls in May rose 390,000 versus the 318,000 expected while the labor-force participation rate improved to 62.3%. Other data prints, however, pointed to signs of slackening growth. The University of Michigan Consumer Sentiment Survey printed at a record low of 50.2 versus 58.4 in the previous month, while the Conference Board Survey of Consumer Expectations decreased to its lowest point since 2013. Housing starts fell by 14.4% in May, significantly below expectations of a 1.8% decline, which was the largest drop since April 2020, as mortgage rates have risen to their highest level since 2008. By the end of the quarter, the Atlanta Fed's GDPNow model estimate for 2Q22 real GDP growth fell to -1.0%(seasonally adjusted annual rate), down from over 2% in early May.

Outside of the US, inflation remained a dominant theme as it surprised to the upside in major economies. In May, European Central Bank (ECB) committee members indicated support for tightening-including a likely initial rate hike in July and the end of negative rates by 3Q22. In June, the ECB confirmed that asset purchases under the Asset Purchase Program (APP) would end on July 1, 2022. The ECB also held an emergency policy

Western Asset Fixed-Income Market

meeting in June to discuss new tools to address concerns over financial fragmentation. For the fifth consecutive meeting, the Bank of England hiked the Bank Rate by 25 bps, to 1.25%, as had been widely expected. Elsewhere, the Swiss, Norwegian, Swedish, Canadian and Australian central banks hiked their key rates by 50 bps. In contrast, the Bank of Japan kept its policy unchanged and reaffirmed its commitment to negative interest rates and yield curve control. In China, Shanghai lifted its months- long Covid lockdown on June 1, which lifted economic sentiment, given that the government's zero-Covid policy and subsequent lockdowns have been weighing on private investment and consumption and adding to economic uncertainty.

The May CPI inflation surprise initially triggered a selloff in rates causing 10-year US Treasury (UST) yields to reach 3.50% by mid-June but growing recession concerns and the risk-off move that followed brought yields significantly lower over the last two weeks of June but still higher over the quarter. Investment-grade and high-yield credit spreads were significantly wider over the quarter as were structured product spreads. USD-denominated emerging market (EM) bond spreads widened and EM local yields were higher and underperformed US yields. The US dollar was significantly stronger versus virtually all developed market (DM) and EM currencies. Over the quarter, UST yields bear-steepened as back-end yields rose slightly more than front-end and intermediate yields; 5s-30s steepened from 2 bps to 13 bps. UST 2-year yields rose from 2.28% to 2.92%, 5-year yields rose from 2.42% to 3.01%, 10-year yields rose from 2.32% to 2.98% and 30-year yields rose from 2.44% to 3.14%.

Outlook

The great secular disinflation trend of the developed world that has been in place for the greater part of 40 years has been severely interrupted. Monetary and fiscal largesse combined with Covid reopening demand set against severely constrained supply was already a tailwind to inflation. The Ukraine/Russia conflict has acutely amplified the problem. The Fed has pivoted to making inflation its primary priority, as it commits to getting the fed funds rate back to the neutral range (characterized by Chair Powell as 2%-3%). The strategy, outlined by Vice Chair John Williams, is to bring core inflation to below 4% this year, 3% next year and 2% in 2024.

Market pessimism about the achievability of these results abounds. Specifically, the strength in the labor market, housing prices and commodity prices has not yet abated. But markets are forward-looking, and the tailwinds to inflation, as daunting as they have been, are giving way to the headwinds facing global and US growth.

In the US, the hawkish Fed pivot increases the odds of a slowdown. Our contention is that monetary policy is focused on demand destruction. Severe supply imbalances, despite the setbacks from developments in Ukraine and China, will slowly but surely heal. Fiscal policy is tightening. Housing supply in the US is accelerating sharply even as mortgage rates have dampened demand. Real incomes are challenged, and the anecdotes from Amazon, Walmart and Target suggest inventories are close to being fully replenished even as consumption growth appears to be stalling. All this bodes well enough for a significantly lower glide path for inflation as the year progresses.

Once again, the fear that Fed tightening will persist to and through a potential economic downturn has prompted most income investors to trim their credit holdings, while even the most bullish remain on the sidelines. Fear seems to have replaced optimism across all credit markets.

It's during times like this when Western Asset portfolios have benefited the most. Adhering to our fundamental, relative value discipline, we recognize that opportunities are created when apprehension and concern drive valuations well beyond fair value. We believe such a time is upon us now. Risk aversion appears to be at an extreme level.

Before the pandemic-and even during the zero-interest-rate Powell policy time period-the question on investors' minds was, "How do I get safe yield?" As far from the recent market tumult as that question seems, there will come a day when it comes front and center again. Locking in attractive spreads against very pessimistic default assumptions in the context of government bonds priced to levels above central bank inflation forecasts has merit. It may take time for inflation to be reined in-but this task is by no means insuperable. Indeed, this could be sharply aided by positive developments such as the dissipation of Covid or a ratcheting down of the Ukraine/Russia conflict. Neither is in immediate sight, but given time, neither is out of the question.

The Fed unleashed its grand experiment in response to a global pandemic. Now it is attempting an abrupt unwind to that experiment. The Fed was originally convinced that inflation would prove transitory, but now is convinced the potential for its permanence justifies taking increasing recession risks. Our view is that as the fed funds rate approaches the 2% level, a more cautious approach would be appropriate in light of slowing growth and inflation, as well as in acknowledgment of unforeseen consequences. We believe that ultimately the path of inflation will prove dominant.

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Western Asset Fixed-Income Market

Risk Disclosures

Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. Fixed-income securities involve interest rate, credit, inflation, and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed-income securities falls. International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Asset-backed,mortgage-backed or mortgage- related securities are subject to prepayment and extension risks. High yield bonds are subject to greater price volatility, liquidity, and possibility of default.

The Consumer Price Index (CPI) tracks prices for a basket of more than 80,000 goods and services.

Core Personal Consumption Expenditures (PCE) refers to the PCE Price Index excluding food and energy. The core PCE price index is closely watched by the Federal Reserve as it conducts monetary policy.

COVID-19 is the World Health Organization's official designation of the current coronavirus disease.

The Federal Open Market Committee (FOMC) consists of twelve members-the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis.

The Federal Reserve Board ("Fed") is responsible for the formulation of policies designed to promote economic growth, full employment, stable prices and a sustainable pattern of international trade and payments.

Gross domestic product (GDP) is an economic statistic that measures the market value of all final goods and services produced within a country in a given period of time.

A mortgage-backed security (MBS) is a type of asset-backed security that is secured by a mortgage or collection of mortgages.

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

Spread refers to the difference between Treasury securities and non-Treasury securities of similar maturity but different credit quality.

Summary of Economic Projections are released by the Federal Reserve four times a year. SEP features the Federal Open Market Committee (FOMC) participants' projections for GDP growth, the unemployment rate, inflation and the appropriate policy interest rate.

U.S. Treasuries are direct debt obligations issued by the U.S. government and backed by its "full faith and credit." The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity.

West Texas Intermediate (WTI) is a popular oil price benchmark. It is the underlying asset in the New York Mercantile Exchange's oil futures contract.

The yield curve shows the relationship between yields and maturity dates for a similar class of bonds.

Franklin Resources, Inc., its specialized investment managers, and its employees are not in the business of providing tax or legal advice to taxpayers. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any such taxpayer for the purpose of avoiding tax penalties or complying with any applicable tax laws or regulations. Tax-related statements, if any, may have been written in connection with the promotion or marketing of the transaction(s) or matter(s) addressed by these materials, to the extent allowed by applicable law. Any such taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.

Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional.

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INVESTMENT PRODUCTS: NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE

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