By Ann Saphir
REUTERS - After an unexpected surge in U.S. job gains in May, traders are now betting the Federal Reserve will start raising interest rates as soon as October, and will make a second increase early next year.
Traders see a 53-percent chance that the first Fed rate hike will come at the Fed's second-to-last meeting of the year, based on CME FedWatch, which tracks rate hike expectations using its Fed funds futures contracts. They see a better-than-even chance that the Fed will have chalked up two rate increases by its January meeting, the same contracts suggest.
Before Friday's report on May jobs, traders appeared convinced that the Fed would need to wait until at least December and perhaps into next year before removing any of its monetary policy accommodation.
An October rate hike had been given worse than even odds, based on the fed funds futures contracts.
"A lot of people have been saying 2016 lately, but now if this continues it's likely to pull that back well back into 2015," said Russell Price, a senior economist at Ameriprise Financial in Troy, Michigan.
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Traders of fed funds futures still discount a September rate hike, the timing preferred by most Wall Street economists, with contracts pricing in just a 34-percent chance of a rate hike then.
The U.S. unemployment rate rose to 5.5 percent in May, from 5.4 percent a month earlier, but investors saw the increase as a sign of labor market strength because it reflected growing optimism over jobs as more people who had been sidelined launched back into the job hunt.
Payrolls increased by 280,000, the biggest gain this year.
The Fed has kept short-term rates near zero since December 2008, and has said it will wait until it sees continued improvement in the labor market and stronger signs that annual inflation is headed back toward the Fed's 2-percent target before raising rates.
The jobs report showed hourly wages rose 2.3 percent, the strongest showing since August 2013. Still, Fed Chair Janet Yellen has said she would see wage gains of 3 percent to 4 percent as signaling a healthy job market.
Fed policymakers are set to meet June 16-17, and traders see no chance they will change policy then, based on the futures contracts.
Starting next week economists at all 12 regional Fed banks and at the Fed's Washington headquarters begin an intensive review of the latest data, including Friday's report, as policymakers develop fresh economic forecasts to help shape their decision-making.
Fed officials had sounded increasingly dovish in recent days as they worried about the lack of a snapback in consumer spending from the first-quarter economic slowdown.
(Reporting by Ann Saphir with reporting by Herb Lash; Editing by Chizu Nomiyama and Nick Zieminski)