B of A analyst says rate move overdone

NEW YORK (Reuters) - This week's volatile action in U.S. interest rate markets reflects short-term traders getting caught out of step more than a fundamental shift in prospects for Federal Reserve policy, a Bank of America strategist said on Wednesday.

Robert Sinche, Bank of America's head of strategy for currencies, global rates and commodities, said that regardless what is now priced into the market, the Fed was unlikely to start an aggressive rate-hike campaign soon because the U.S. economy is still too weak.

"In the last week or so we've seen what probably would be described as disorderly conditions in a variety of markets," Sinche said at the Reuters Investment Outlook Summit in New York.

Swings in the U.S. Treasury yield curve have been "virtually unprecedented," including one in the 2-year/30-year curve as large as that in 2001, when the Treasury Department announced it would stop issuing long bonds, he said.

Sinche said many market participants were caught flat-footed when tentative signs that crude oil prices had peaked quickly gave way to a massive two-day rally.

At the same time, "the Fed started talking about inflation risk, and there were a lot of positions being unwound," he said. "I don't think there's a major allocation shift; this is more short-term trading desk action."

Interest rate futures, which measure expectations toward Fed policy, slumped on Monday and Tuesday on a wave of tough talk on inflation by Federal Reserve officials, including Chairman Ben Bernanke and Dallas Fed President Richard Fisher.

Futures now point to a half-point increase in the federal funds rate by October, from 2 percent now. That compares with an implied 40 percent chance of just a one-quarter point hike at the end of last week.

By mid-2009 futures suggest fed funds will be between 3.25 percent and 3.5 percent.

"It's hard to believe the Fed is comfortable with a 150 basis point increase in fed funds being priced in over the next year," Sinche said.

(For summit blog: summitnotebook.reuters.com/)

(Reporting by Ros Krasny; Editing by Leslie Adler)