Fear of a worldwide recession is actually helping the dollar gain ground after months of decline.
Investors around the world think that a global slowdown will be bad for foreign economies, so they are buying up U.S. assets. The dollar is already down 10.4 percent from its high against the euro of 1.60 set on July 15.
Since they need dollars to do that, the flight to quality is also strengthening the greenback. According to a new Merrill Lynch survey, fund managers' fear of inflation has hit its lowest level since 2001.
Now, 18 percent of fund managers think global core inflation (that is, inflation minus food and energy) will actually fall in the coming 12 months. Falling oil prices, which feed into other products by driving up production and raw materials costs, is behind the change of views.
Plus, 24 percent of the fund panel now think that the global economy has already entered a recession, up from 20 percent in July and 16 percent of them in June. Meanwhile, just 9 percent think that companies are under leveraged, down from as high as 40 percent believing so at the end of 2007.
"The message from investors to corporates is that if we are headed for a recession, they should clean up their balance sheets and prepare a financial buffer," says Karen Olney, chief European equities strategist at Merrill Lynch.
"As banks de-lever, non-financial corporates will have to wake up a to far less flexible world of credit."
All this adds up to money flowing from emerging economies, where investors have been betting on higher, and safer, returns, and back to dollar-based assets.
It's a bet that can pay off in two ways: There is the safety and potential upside of a U.S. recovery, but many managers also have come to believe that the dollar is undervalued. Thus, investments in dollars can gain from both equity and currency appreciation.
Seventy-one percent of fund managers now call the euro "overvalued," according to the survey. Investors also believe that the United States has a better corporate profit outlook and higher quality earnings than the eurozone.
In Europe itself, investors have begun to sell shares in oil producers and instead are buying discretionary consumer stocks, like retail stores, and electronics manufacturers. Technology and media companies, which depend on consumers to prosper, are back in favor, Merrill Lynch reported.
Meanwhile, European investors as a group are even less concerned about inflation than the global panel. Nearly half think inflation will fall over the next 12 months.
"The market appears to have overreacted to a fall in the oil price, and investors have turned a blind eye to second round effects of inflation, such as rising wages," said Olney.
"It will take several months of slowing global growth to be sure that the inflationary dragon has been slain."
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