* Prices gain on fears over Cyprus contagion * Bond rally squeezes shorts, prompts short covering * Fed buys $3.14 billion in notes due 2020-2023 NEW YORK, March 19 U.S. Treasuries prices rose on Tuesday as a plan to tax bank accounts in Cyprus to help pay for a bailout unnerved investors, who fretted other euro zone countries could follow a similar path. Benchmark yields hit a two-week low in the wake of demands for the levy by European partners as a condition of helping the island country avoid default. Riskier assets such as stocks and some currencies have slid all week on the news, with investors running for the safe haven of U.S. government debt instead. Adding to global uncertainty, Cypriot lawmakers overwhelmingly rejected the deeply unpopular tax on Tuesday, throwing into doubt an international bailout needed for the country to avert default and a banking collapse. At the same time, French Finance Minister Pierre Moscovici said the euro zone could not lend Cyprus any more, since the country's debt would become unmanageable. "You don't know if this is a new way for the EU and the IMF to start to curb the debt issues in Europe. There are some people saying it could occur in Italy and Spain, that is really where the fear is building and why Treasuries are reacting the way they are. It's a contagion fear," said Jason Rogan, managing director in Treasuries trading at Guggenheim Partners in New York. Further fueling the rally, investors who had positioned for more gains in yields on strengthening U.S. economic data got caught by surprise and have had to cover short sales. "Cyprus killed any move to higher yields as of right now," Rogan said. Benchmark 10-year notes were last up 16/32 in price to yield 1.899 percent, down from 1.96 percent late on Monday. Thirty-year bonds gained 1-6/32 in price to yield 3.123 percent, down from 3.18 percent. Investors will keep a close eye on Cyprus in coming days, with an eye to any sign that countries such as Italy and Spain are feeling renewed stress. "The outcome in Cyprus will be the main driver of the markets right now," said Justin Lederer, an interest rate strategist at Cantor Fitzgerald in New York. "There are still many issues out there, and a lot of that's not solved, and that's what keeps the underlying bid in the safe havens," he said. The news from Cyprus overshadowed this week's Federal Reserve meeting. Investors are watching for signs of when Fed Chairman Ben Bernanke might consider tapering or ending bond purchases as recent data have pointed to gathering momentum in the world's biggest economy. Most Wall Street economists expect the Fed will continue its bond purchases through 2013 before tapering or ending the buybacks in 2014. Uncertainty in Cyprus, and fears that it may spread into other countries in the euro zone and harm economic prospects there, might give the Fed further reason to continue its bond purchases, traders said. The Fed bought $3.14 billion in notes due 2020 and 2023 on Tuesday as part of its ongoing purchase program.