Signs that the world economy is at a turning point are being reflected by tentative evidence that bonds are moving back into favor after years as an unloved alternative to booming equities.

The question is whether investors' recent embrace is a peck on the cheeks as market risks rise or a more passionate affair that will last.

Exhibit A in the case for bonds comes from investor surveys. Merrill Lynch's August survey of global fund managers showed bonds making a comeback.

The percentage of respondents saying they were underweight bonds fell to 56 percent from 70 a month earlier while the number of fund managers who said they were overweight in equities dropped to 44 percent from 54.

Reuters' most recent global asset allocation polls showed a similar, if not quite as dramatic, shift.

In the Reuters global poll, the average portfolio allocation to bonds rose to 33.3 percent in July from 33.0 percent in June, the highest level in a year. August polls are due on Thursday.

Exhibit B comes from market flows. U.S. financial services firm State Street says bond buying is heavy within the $10.9 trillion in institutional investor money it holds as custodian.

Overseas investors have been buying Japanese bonds (JGBs) at a higher rate than 96 percent of the time during the past decade, euro zone government bonds at more than 85 percent and U.S. Treasuries at a well-above-average 62 percent.

Add to this actual performance. Citigroup says in the first three weeks of August, U.S. bonds returned 0.85 percent, JGBs 0.44 percent, and euro zone government debt 0.24 percent - which compares with losses over the seven months to end-July.

FRAUGHT FUTURE

The renewed interest in bonds has been triggered by signs rising interest rates have begun to slow the U.S. economy, which threatens to spill over into the rest of the world.

Recent U.S. data has shown falling sales of new U.S. homes and durable goods orders, soft consumer sentiment and dipping leading indicators.

As a result, investors appear to have - in the words of Ryan Shea, a State Street Global Markets senior strategist - been buying into the growth slowdown scenario.

It has prompted a number of investment houses to look afresh at bonds.

We are coming back to a more neutral position in the U.S. bond market, said Michala Marcussen, strategy director at France's Societe Generale Asset Management, pointing to the U.S. Federal Reserve's recent pause in interest rate hikes.

Switzerland-based wealth manager BSI has been telling clients to prepare for declining global bond yields, anything from a half a percent on 10-year Treasuries to a quarter on British Gilts over a year.

Britain's Standard Life Investments moved to neutral in international bonds, primarily Treasuries, at the end of the second quarter. A long-time bond bear, it had been underweight since at least the beginning of the economic cycle.

ALL CHANGE?

Whether this trend builds depends on the direction of the U.S. and global economies. Those who expect a significant slowdown are much more likely to be digging deep into bond markets than those looking for more modest decline.

Dresdner Kleinwort, for example, sees a sharp downturn in the global economy.

The bank's chief strategist, Albert Edwards, is thus looking for a re-rating of bonds, with 10-year Treasury yields below 3 percent versus today's 4.8 percent and euro zone equivalents at 2.5 percent versus 3.8 percent now.

U.S. bond firm PIMCO is less apocalyptic but still sees what Emanuele Ravano, a managing director in Europe, calls a pretty meaningful slowdown.

A U.S. housing slump will damage related industries, hit consumer confidence and dry up borrowing, PIMCO reckons, spreading to economies abroad. One result is PIMCO is very keen on short-end U.S. debt.

But others see a more gentle slowdown and question whether any rally in bonds can last.

Equities have been doing relatively well while bond demand has been rising - MSCI's main world stock index is up nearly 3 percent in August - and big investors have plenty of cash available to jump in deeper once risks become clearer.

And bonds, while cheaper than they were, are still relatively expensive.

Societe Generale's Marcussen reckons it does not take much to put investors off.

People feel quite comfortable buying the (U.S.) 10-year at 5 percent, she said. Maybe at 4.80 they become more hesitant.

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