Fed seen raising rates in October as job market firms

(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.

Federal fund futures contracts show that traders see a 52 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.

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 fed funds futures contracts traded at CME Group's Chicago Board of Trade.

"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, Mich.

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 formerly 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.

(Reporting by Ann Saphir with reporting by Herb Lash; Editing by Chizu Nomiyama)

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