TREASURIES-Losses build in concession for 2-year auction

* Demand seen for $38 billion two-year note auction

* Safety bid revives after stocks erase most gains

* Bid emerges at 10-yr 3.04 pct-3.065 pct support area (Updates ahead of two-year note auction)

By Ellen Freilich

NEW YORK, July 27 (Reuters) - U.S. Treasuries prices fell on Tuesday, building in a concession for the Treasury's two-year note auction this afternoon.

In when-issued trade, the two-year note to be sold at 1 p.m. (1700 GMT), yielded 0.68 percent as investors sold Treasuries to cheapen the price on the note ahead of the auction. Traders said the sale would draw demand.

Traders said the Treasury's auction of $38 billion in two-year notes would not be difficult for the market to digest, especially with the concession that began overnight.

The cheapening of the when-issued two-year notes from Monday's close has created a "favorable" setup for the $38 billion sale, said Thomas di Galoma, head of fixed-income rates trading at Guggenheim Securities in New York.

"The 2s are still very attractive on the rolldown," he said, referring to the interest paid on the investment in the form of accrued interest or coupon.

As technicals have turned negative for Treasuries, additional concessions should take place to absorb the rest of the week's note supply beyond the $38 billion two-year notes.

The Treasury will sell five-year notes on Wednesday and seven-year notes on Thursday.

Technical buying emerged when the 10-year yield moved to the 3.04 to 3.065 percent area, said John Spinello, chief fixed-income technical strategist at Jefferies & Co.

"After Treasuries had rallied to such low levels (in yields), you have to expect a settling back of the market as we come into supply here," said Robert Tipp, chief investment strategist for Prudential Fixed Income, whose team helps oversee approximately $240 billion in fixed income assets.

"You have to find a new equilibrium for the front end of the Treasury market in the post stress-test world," he said.

In when-issued trade, the two-, five- and seven-year notes to be sold on Tuesday, Wednesday, and Thursday, respectively, yielded 0.685 percent, 1.83 percent and 2.498 percent.

FOUR- and 52-WEEK BILL AUCTIONS

Two auctions of shorter-term Treasuries on Tuesday - four- and 52- week bills - went well, despite the amount of supply being auctioned, said Thomas Simons, money market economist at Jefferies & Co. in New York.

"The 3.94 bid cover in today's 52-week bill auction was the lowest since April 6, but in the context of today's supply, this does not show significant weakness," he said.

Simons said the direct bid for the 52-week bills was "strong" again at 18.4 percent, the second largest bid since the record 35.7 percent takedown generated by the October 2008 auction, the midst of the U.S. financial crisis.

"The auctions put up somewhat underwhelming statistics on the surface," Simons said. "However, in the context of the day's supply calendar, both went rather well."

Simons said only two year-bill auctions have been held on the same day as 2-year note auctions. In October 2009, both the year-bill and two-year note auctions stopped short. In July 2009, the year-bill stopped short while the 2-year tailed.

Benchmark U.S. 10-year Treasury notes fell 16/32 on Tuesday, their yields rising to 3.05 percent from 2.99 percent late on Monday.

Spinello said the 3 percent yield on the 10-year note was merely a psychological boundary. However, foreign buyers' resolve to buy on dips is "critical," he said. (Editing by Andrew Hay)