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The good news is fund managers have become less worried about the possiblity of a recession than they were a month ago. The bad news is that’s where the good news ends.

A vast majority of managers believe we are mired in a world of below-trend growth and above-trend inflation, according to Merrill Lynch’s latest survey of global fund managers. Three months ago, 67% of the panel was bracing itself for stagflation; this month that percentage has risen to 85%.

On the growth front, optimism is rising. Fund managers are marginally less negative on expectations for both economic growth and corporate earnings, the survey showed. The percentage of panelists thinking that the world is already in recession fell from 24% in April to only 18% in May. At the same time, the percentage of managers of the opinion that a global recession would be “likely” in the next 12 months fell from 40% to just 29%.

But this month also saw a sharp rise in the net balance expecting inflation to rise over the coming year. A quarter of the respondents now say they expect global core inflation to rise in the next 12 months, compared with only 7% in April.

“Stagflation fears are gripping investors, but inflation concerns are fast overtaking worries about economic growth,” the survey said.

All this doesn’t bode well for equities, especially given the stock market’s 10% bounce since its March lows. Gloom about the corporate-profit outlook remains, with a net 77% of those polled thought consensus estimates for global corporate earnings were still too high.

“This may explain why investors are starting to question equity valuations - only a net 15% of the panel now think stocks are undervalued, compared with 26% in April,” the survey said.

Growing inflation fear is also prompting predictions of higher bond yields, with 80% of respondents expecting long-term rates to be higher a year from now. “Evidence is pointing to a possible sell-off in bonds,” according to the survey. And a sharp rise in bond yields “could help convert this financial crisis into an economic crisis.”

For Jamie Dimon of JPMorgan Chase, being chief executive of the only Wall Street financial institution to post positive returns on its stock year-to-date can not only be a blessing, but also a curse.

As with any great accomplishment, success is often accompanied by a certain level of credibility and respect.Which is why, when Dimon spoke at a presentation in New York on Monday, the investment world was listening intently. Unfortunately, it didn’t like the message it heard.

“Mr. Dimon may have the most negative outlook of anyone in the industry,” Ladenburg Thalmann analyst Richard Bove said, maintaining a neutral rating. “He made two positive comments; the financial crisis is 75% over and will be gone by year-end; and JPMorgan has a very strong balance sheet. But that was it.” Bove, who admits to viewing Dimon as “completely candid” and “much smarter than the average financial company executive,” said it was depressing listening to the savior of Bear Stearns speak. “Mr. Dimon is convinced that the recession is just beginning. Moreover, he feels that this recession will be more severe than any seen in this country for 25 years,” Bove said.

The recession will be driven by problems in the oil, housing, consumer and financial sectors, according to Bove’s interpretation of Dimon’s presentation; there’s also likely to be more develeraging of the financial sector that will result in lower revenue potential and banks that won’t recognize losses fast enough. Dimon said that just about every type of consumer loan will deteriorate in quality, resulting in more losses at JPMorgan’s subprime and prime mortgage businesses, while the home equity portfolio will also deteriorate and credit card losses will grow.

Oppenheimer analyst Meredith Whitney also acknowledged that the credit card industry is headed toward rough days after she met with JPMorgan’s Gordon Smith, head of credit cards. Whitney, who holds a perform rating on shares of JPMorgan, said that Smith noted the company’s first bucket delinquencies are down year-over-year while other delinquency buckets are also seeing increased loss severity. Even though Dimon said Monday that JPMorgan expects credit card loss of about 5% in the second quarter, over 5% in the second half of 2008, and an average of 6% in 2009, Oppenheimer in fact believes the losses will be higher than JPM’s own expectations.

“JPMorgan believes that losses in the second half of 2008 will be mitigated by a higher denominator from a seasonal rise in balances, however we actually believe the opposite will occur,” Whitney said.

Still, as Bove pointed out, JPMorgan’s stock continued to rise Monday, even after the bearish comments from CEO Dimon. “Investors should listen to Mr. Dimon before rushing in to this stock,” Bove wrote. Investors did just that Tuesday, sending the stock down 2.5%.

The April jobs report offers a little something for both bulls and bears. Perhaps the only definite thing that can be said is the recession debate will continue.

The Labor Department said Friday the U.S. economy shed 20,000 jobs last month, not anywhere near the 75,000-85,000 decline forecast by most economists. The unemployment rate also unexpected fell to 5% from 5.1%, vs. expectations of a rise to 5.2%.

Predictions of a deep recession suddenly look premature, with a few economists now suggesting that the U.S. economy may even narrowly avoid the R-word. While payrolls have fallen for four straight months (with a total loss of 260,000), job lossese are way below the recession norm. During the last 3 recessions, there was a string of job losses that lasted for a minimum of 10 months, with the largest single month job loss at more than 300,000. (see related post).

“It appears that the economy is still just dancing around the perimeter separating recession from a growth slowdown,” said Michael Englund, economist at research firm Action Economics. “The payroll figures on their own still indicate that the economy is in recession, but just barely. And the outlook is more ambiguous when the other major indicators are added to the mix, as the bulk of other reports are notably out-performing a recession path.”

Or, as T.J. Marta, fixed-income strategist at RBC Capital Markets aruges, “if the current period does eventually get classified as a recession, it could very well be characterized as a ‘joblossless recession,’ much as the 2003 recovery was called the ‘jobless recovery.‘”

The jobs report give bears some ammunition, too. There are “some ‘devil-type’ characteristics in the employment report,” said Merrill Lynch’s North American Economist David Rosenberg. For example, he said, while companies did not cut as many positions as expected, they cut the hours instead. In addition, where there was a nice rebound in the household survey, it was all because of part-time employment. May is likely going to prove to be a much more difficult month for payrolls, he said, and “we could see the first triple-digit decline since March 2003.”

Nonfarm payrolls have shown three consecutive months of declines, for the first time since June 2003, and this might only be the beginning of more bad news from the U.S. labor market, some analysts said.

Kathy Lien, chief strategist at DailyFX.com, said that during the three recessions in the U.S. economy over the past three decades, there were a string of job losses that lasted for a minimum of 10 months. “We are already beginning to see this trend unfold and it will be months before we will actually see job growth,” she said. “The largest single month job loss in each of the recessions was more than 300,000,” Lien said. “We wouldn’t be surprised to see the same degree of job losses in this business cycle.”

During the 2000 to 2002 recession, the U.S. had as many as 15 consecutive months of negative payrolls between March 2001 and May 2002, according to Ashraf Laidi, chief foreign-exchange strategist at CMC Markets in New York. The 1990 recession saw job losses continue for 11 consecutive months between July 1990 and May 1991, he said.

“In the current slowdown (not yet officially declared a recession), we’re only in the third-straight monthly decline in payrolls,” he wrote to clients. “Thus, to be consistent with previous recessions, payrolls will likely register negative readings for the rest of the year into [the first quarter] 2009,” he said. “This also means that the unemployment rate will likely climb to as high as 5.9% to 6.0%.”

But not every economist is so bearish. Tony Crescenzi, a strategist at Miller Tabak, said today’s jobs data support “the idea that the contraction will be short and shallow - the Great Moderation of economic growth seen over the past 25 years is continuing.” Data on the average workweek and aggregate hours, the GDP proxy, are encouraging. “The workweek advanced a tenth of an hour to 33.8, an increase that is the income equivalent of several hundred thousand new jobs,” he said.

The payroll drop of 80,000 last month is far below the type of decrease normally seen in an economic recession when job losses tend to move to as high as 300,000 per month, Crescenzi said. In the second month of the 2001 recession, 281,000 jobs were lost. Similarly, in the 1990-1991 recession, 204,000 jobs were lost in the second month of the recession.

“The idea of short and shallow was the main theme that emerged this week on the economy, particularly following the Chicago index on Monday and the two ISM [Institute of Supply Management] indexes, and today’s data fit with this theme,” he wrote in a research note. “I expect the short and shallow idea to dominate in May when tax rebate checks are spent. Whether it lasts is a consideration for another day.”

Because economists have said the U.S. needs to create about 100,000 jobs each month to keep up with new entrants to the workforce, and payrolls have fallen for the second straight month, then the recession must officially be here. The jobs report says so.

Early Friday, the Labor Department said U.S. employers shed more jobs last month than in any month in almost five years. Payrolls fell by 63,000 in February, and January’s 17,000 decline was revised lower to 22,000.

The latest figures pushed the three-month moving average to a 15,000 decline, the lowest level since July 2003.

“Today’s jobs report is the nail in the recession coffin as the losses in payrolls are not only deepening but also broadening into other sectors,” said CMC Markets Chief Forex Strategist Ashraf Laidi. He added that annual inflation above 4.0% and annual average hourly earnings growth at less than 4.0%, puts real earnings at their lowest in two years.

Bernanke may have already hinted that the U.S. is in a recession when he said today’s conditions are more challenging than in 2001, Laidi said. This downturn will be especially challenging, bearing “an ominous combination of the worst of the last three recessions; namely rising inflation of the early 1980s; surging oil prices and housing recession of 1989-90; and falling equity markets of 2001-02.”

“The 63,000 drop in Feb., and the directional change in the last three months is consistent with recession, though the 4.8% unemployment rate is not,” said Joeff Hall, Thomson Financial managing economist. “I’m discouraged by the lack of job creation, but I believe firms are holding back on hiring because of uncertainty rather than outright economic conditions. That said, the worsening credit crisis is making it tougher for me to cheer about this economy.”

Despite the jobs report, which was distinctly worse than the 25,000 job gain which analysts polled by Thomson’s IFR Markets had expected, stock markets and equity futures rose earlier in the session after the Federal Reserve announced it will raise the amount of liquidity in its TAF auctions to $100 billion to “address heightened liquidity pressures in term funding markets.” Investors took back gains, however, and the Dow Jones Industrial Average lost 146 points by the end of the session.

Laidi predicts that, despite the Fed’s stepping up of liquidity operations, it will be forced to slash benchmark interest rates to 2.00% by end of the second quarter. He sees about a 70% chance of 1.50% Fed funds rate by end of year. The payroll report, he added, is an “indisputable negative for the already damaged dollar especially considering the [European Central Bank's] tacit support for its record-high euro.” Nonetheless, the U.S. dollar index ended 5 cents higher at $73.04.

One question to ask is how could job report estimates have been so wrong. Part of the answer, Laidi said, is related to why most economists never expected rate cuts in 2007, or recession in 2008.

Federal Reserve Chairman Ben Bernanke is fighting a three-front war: recession, inflation, and credit market depression. The question, then: Is the Fed capable?

The Fed has cut rates and taken a series of liquidity-boosting measures over the past few months, yet there’s no sign the credit market crisis is receding; the U.S. economy remains on track for a recession.

The Federal Reserve said on Friday it’ll raise the total size of its March TAF (Term Auction Facilities) auctions to $100 billion and begin 28-day term repurchase agreements that are expected to total $100 billion, to “address heightened liquidity pressures in term funding markets.” The TAF is a targeted facility that allows banks to access funds at interest rates lower than those offered at the discount window. The Fed also said it’ll expand the ways it delivers liquidity to banks, which includes using less-liquid assets as collateral for term repurchase transactions.

You can bring a horse to water, but you can’t make it drink. Senior Fed officials warned that while these decisions were in response to the rapid deterioration in term funding markets, they are not sure their new measures will calm the turmoil in the credit markets.

Financial markets are still expecting the Fed to aggressively lower interest rates in the coming months. An Action Economics weekly survey showed all are expecting at least a 50-basis points reduction in the federal funds rate to 2.5% from the current 3% by the March 18 policy-setting meeting. According to the survey, fed funds estimates ranged from 2.50% to 2.25% for the March policy meeting, and 2.5% to 1.5% by June.

But the question remains: is it possible that no matter how low the Fed cut rates, it won’t stop the economy and credit markets from worsening? New York Fed President Timothy Geithner said very directly in a speech Thursday that “even with those reductions in short-term interest rates in place, financial conditions have tightened as risk spreads on a wide range of asset classes and institutions have increased considerably.” He said “we cannot know with confidence today what level of the short-term real funds rate will be consistent with our objectives of sustainable growth and low inflation.”

Tony Crescenzi, market strategist at Miller Tabak, is more optimistic, believing the Fed still has more aces up its sleeve. if the Fed’s new TAF measures fail, and if the term markets seize up, Crescenzi said he would expect that “the Fed would consider purchasing agencies for their own account.”

“The Fed currently owns only Treasuries but has the authority to buy agencies,” he said. “Another possibility mentioned by Bernanke in 2002 is the idea that the Fed would buy long-term Treasuries. These are both extreme measures but they are potent tools.”