Fund managers have turned more upbeat about the global economy, according to Merrill Lynch’s latest survey of fund managers.

The U.S. Federal Reserve’s decision last month to hold interest rates steady has assuaged inflationary fears, it notes. Only 3% of respondents expect core inflation to be higher one year from now, versus 24% in August. A second boost has come from oil prices, which were US$10 per barrel lower during fieldwork for this survey than they were a month earlier, Merrill said.

Fund managers’ lingering concern is the outlook for corporate earnings, it noted. A net 54% of respondents believe that corporate earnings will deteriorate over the coming year — the worst reading since early 2001.

“Given how relaxed investors are about inflation, the only surprise is that investors are not being more robust in their investment strategies,” said David Bowers on behalf of Merrill Lynch. “The Fed’s decision to hold rates is encouraging, but perhaps what investors are waiting for is an interest rate cut.”

Inflationary fears have been steadily dissipating since June, Merrill reported, adding that more than a third of the panel actually expect global inflation to fall over the coming year. As further evidence that investors believe inflation is under control, twice as many asset allocators believe the Fed should view slower growth as its primary concern than cite inflation as the Fed’s No. 1 enemy.

The Fed’s decision to hold interest rates level has at last prompted investors to invest their cash. On average, 4% of assets are currently being held in cash, down from 4.4% in August. Only a net 20% of respondents admit being overweight cash relative to their benchmark, versus 30% a month ago.

Fund managers continue to favour the Japanese yen and shun the US dollar, even though this strategy has yet to bear fruit, it said. A net 46% of investors expect the US dollar to depreciate over the next 12 months, while 43% of the panel foresee a stronger yen.

Alex Patelis, head of global foreign exchange and local currency strategy at Merrill Lynch, believes this strategy will be vindicated. His team examined 16 episodes of reversals in current account deficits in industrial countries from 1984 to 2003 and found that a country’s currency typically continues to slide for three years after its deficit peaks. “We expect the US dollar will continue to slide, with US inflation remaining higher than elsewhere and US growth slowing substantially,” said Patelis. He also believes the bullish case for the yen remains intact. “The yen remains the most undervalued G10 currency. A global tightening cycle would support its outperformance and Japan’s economic outlook is robust,” he noted.

A total of 222 fund managers participated in the global survey from September 1 to September 7.