Merrill Lynch reports that its latest survey of fund managers finds that inflation fears have virtually disappeared, reaching their lowest level since the downturn of late 2001.

The survey found that 18% now expect global core inflation to fall in the coming 12 months. In June’s survey, 33% thought inflation would rise. A falling oil price and growing evidence of recession have prompted this rethink, it said.

While inflation fears have dropped, more investors believe that the global economy has already entered recession — up to 24% from 20% in July and 16% in June.

With the economic downturn spreading to the eurozone and certain emerging markets, investors are starting to view U.S. assets as attractive, Merrill reported. The proportion of asset allocators overweight U.S. equities stands at 12%, its highest level in more than six years. Supporting this view is the widely held belief that the U.S. dollar is undervalued, it noted, as 58% say that the dollar is undervalued, while 71% say the euro is overvalued. Investors also believe that the U.S. has a better corporate profit outlook and higher quality earnings than the eurozone.

Globally, investors want to see companies paying close attention to their balance sheets. The percentage of investors who believe corporates are under leveraged has tumbled to 9%, down from nearly 40% at the end of 2007, it reported. “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,” said Karen Olney, chief European equities strategist at Merrill Lynch. “As banks de-lever, non financial corporates will have to wake up to far less flexible world of credit.”

Also, as oil prices have eased, investors have reduced overweight positions in energy and started closing underweight positions in financials. According to Stuart Graham, head of European bank equity research, write-downs are coming to an end and banks have completed more than half of their capital raising, however doubts remain about the sector’s ability to bounce back quickly.

“Banks are highly unlikely to see a V-shaped recovery in their share price given the uncertainties in the market,” said Graham. “Apart from the economic outlook, a key question is how stringent regulators will be in setting new rules to govern banks’ capital ratios. No one yet knows what the appropriate capital structure of the future is.”

A total of 193 fund managers participated in the global survey from August 1 to 7.