Rafael Gallardo, head of economic research, described the economic recovery as “mostly policy-driven and thus still very fragile,” and thinks monetary tightening will be difficult and create a climate of high volatility.

Mr Gallardo, however, sees no urgent need for monetary tightening, as AXA IM’s inflation forecasts for 2010 are subdued – 2 per cent in the US and UK, and 1.2 per cent in the euro-zone.

AXA IM’s likely policy scenario is for the Federal Reserve and European Central Bank to delay their first rate increase until 2011. It expects the Bank of England to raise rates by 50 basis points in the fourth quarter of 2010, after increasing its quantitative easing target to £225 billion (approx $366 billion) in the first quarter.

Continued support will be necessary as many structural hurdles to growth persist in developed economies, according to AXA IM, and the withdrawal of support will create much more difficult market conditions.

In 2010, AXA IM predicts the US to grow by 2.7 per cent, the euro-zone by 1.3 per cent, and the UK by 1.6 per cent. It expects Japan-ex Asia to grow by 7.1 per cent.

“Fundamentals appear much brighter for emerging markets,” said Mr Gallardo. However he added that these economies face possible dangers from ultra-loose global monetary conditions, including hot money flows and asset bubbles.

Talk of asset bubbles demonstrates what an incredible rebound markets have experienced in 2009, and the environment continues to favour risky assets, said Sebastian Paris-Horvitz, head of investment strategy.

Corporate credit valuations remain attractive, with markets pricing in default rates well above worst historical case scenarios, according to AXA IM. 

However, Mr Paris-Horvitz said most commodities – especially some metals – had now priced in the good news of the recovery.

Equity valuations are not challenging despite the rallies, but 2010 will not offer the easy gains of 2009 in sectors such as financials and materials, and complacency about liquidity-driven bubbles could prove dangerous, said Mr Paris-Horvitz.

Being selective on sectors and individual companies will be more important in 2010, and stock picking is where market-beating returns, or alpha, will come from, and how fund managers will distinguish themselves, said Mr Paris-Horvitz, adding that investors need to look at restructuring deals, as the “M&A story is certainly going to be strong as in all recoveries”.