U.S. Government Fund

U.S. Government

as of June 30, 2010

Treasuries staged an impressive rally during the past three months, mostly due to reduced investor concern about inflation, a flight-to-quality rally and worsening economic data. In a reversal of the first quarter trend, Treasuries were the best-performing area of the bond market.

Consumer spending, home sales, consumer confidence, global shipping rates, inventory data and payrolls all came in below expectations during the quarter. Anxiety over financial regulation, worries over municipal debt and the ongoing oil leak in the Gulf added to the dour mood. Events in Europe culminated in the downgrade of Greece's credit rating to "junk" status, while central banks in Europe were forced to expend several billion euros to support the sovereign debt markets. Worries over sovereign contagion rippled through risk markets, fueling the flight to quality. Here in the United States, the Federal Open Market Committee, along with many economists, downgraded their estimates for economic growth. As the effects of government stimulus wane and the appetite for further stimulus stalls, the strength of the recovery remains very much in question. As a result, it now appears that the Federal Reserve will not raise rates until well into next year despite the record low level of interest rates.

The U.S. Government Fund returned 3.23% and outperformed its benchmark during the second quarter. Our yield curve and duration positioning added positively to performance, while security selection detracted. We continue to focus investing in liquid assets, and we are monitoring economic data closely for signs of slower-than-expected growth.

If you're a conservative investor who prefers the income and quality assurance offered by government securities, you may find this Fund attractive. It is best suited for investors with relatively low-risk profiles and can provide a solid-core holding for income-oriented investors of all ages.

Invest primarily in securities issued or guaranteed by the U.S. government or by its agencies.
Select high-quality securities with maturities, under normal circumstances, between one and 10 years, with risk exposure managed in an effort to achieve reasonable returns.
Buy and sell securities using a relative value approach that employs models that analyze and compare expected returns and assumed risks.

Not FDIC insured | May lose value | No bank guarantee

†Northern tax-exempt fixed income funds' Average Duration is calculated using the modified duration formula. Other Northern fixed income funds show the option-adjusted duration. Duration is a measure of a bond fund's sensitivity to changes in interest rates.

*Distribution rate and tax-equivalent distribution rate represent the annualization of the Fund's distributions for the prior month ending on the date shown, including capital gain distributions. The 30-day SEC yield and tax-equivalent 30-day SEC yield represent the annualization of the Fund's net investment income, excluding capital gain income. The tax-equivalent distribution rate and tax-equivalent 30-day SEC yield are based on an assumed tax rate of 38.0% for Arizona, 41.0% for California and 35.0% for national municipal funds.

**Per share paid out July 26 with a record date of July 23. The amount shown represents dividends paid for net investment income and excludes distributions from capital gain income.

Please carefully read the prospectus and summary prospectus and consider the investment objectives, risks, charges and expenses of Northern Funds before investing. Call 800-595-9111 to obtain a prospectus and summary prospectus, which contains this and other information about the funds.