Merrill Lynch’s Survey of Fund Managers for May finds that institutional investors’ inflation concerns are fast overtaking worries about economic growth.

In the latest edition of the monthly survey, fund managers were found to be slightly less negative in their expectations for economic growth and corporate earnings. Fewer respondents believe the world has already entered recession — 18% took that view in May, down from 24% in April. The number expecting recession within a year fell to 29% from 40%.

Instead of worrying about recession, investors are focusing on inflation, the survey found. A quarter of respondents expect global core inflation to rise in the coming 12 months, compared with just 7% in April. This is prompting predictions of higher bond yields, with 80% of investors expecting long-term rates to be higher a year from now. In contrast, fewer respondents are predicting higher short-term rates.

“Evidence is pointing to a possible sell off in bonds as inflation worries mount,” said David Bowers, independent consultant to Merrill Lynch. “A sharp rise in bond yields could help convert this financial crisis into an economic crisis.”

Despite the perceived lower risk of recession, investors still worry that earnings estimates are detached from reality, Merrill said. It reported that more than three quarters of investors said that consensus estimates for global corporate earnings are too high.

Additionally, fewer investors see value in equities. The number of investors who believe that equities are undervalued fell to 15% in May, which is down from 26% in April. Fears of overvaluation are also apparent in commodities. It noted that 52% of asset allocators said that they thought oil is overvalued, and 29% of asset allocators thought gold is trading above fundamentals.

A total of 191 fund managers participated in the global survey from May 2 to 8, managing a total of US$615 billion.