* U.S. Treasury to sell $32 billion two-year notes * Smallest monthly two-year auction in over five years * Fed buys $5.08 billion government bonds due 2017-2018 By Richard Leong NEW YORK, Oct 28 U.S. Treasuries prices were unchanged on Monday as investors prepared to make room for this week's $96 billion in longer-dated government debt supply with yields hovering near three-month lows. Bond prices recouped much of their initial decline on light trading volume after surprisingly weak data on pending domestic home sales, reviving some safe-haven bids for bonds. The figures suggested the housing recovery was losing momentum from this summer's spike in mortgage rates even before this month's 16-day partial government shutdown. Analysts, however, downplayed the market's reception to the disappointing housing report. "It's hard to read into the data in the next month or two. They're so skewed," said Justin Lederer, Treasury strategist with Cantor Fitzgerald in New York. The Treasury Department will kick off this week's auctions of coupon-bearing issues with a $32 billion offering of two-year notes at 1 p.m. (1700 GMT). This is the smallest monthly supply of this maturity since August 2008. The government began reducing the size of its two-year auctions in August as a result of lower borrowing needs and in preparing to introduce two-year floating-rate debt in early 2014. The two-year auction will be followed by a $35 billion sale of five-year notes on Tuesday and a $29 billion auction in seven-year notes on Wednesday. Traders and analysts anticipated solid demand for the latest supply due to expectations the Federal Reserve will likely stick to its current pace of bond-purchase stimulus to support an economic recovery weakened by the recent 16-day partial government shutdown. "The prevalent opinion of the market is the Fed is on hold with tapering until 2014," said Mike Cullinane, head of Treasuries trading at D.A. Davidson at St. Petersburg, Florida. "This week's supply should be well-received." Fed policymakers will meet on Tuesday and Wednesday. They surprised investors last month when they refrained from reducing their $85 billion monthly purchases of Treasuries and mortgage-backed securities, or QE3. The decision spurred a bond market rally, helping send the 10-year yield down some 50 basis points from a 25-month high of 3 percent. The Fed bought $5.08 billion of Treasuries maturing Oct. 2017 to June 2018 as its latest QE3 purchase. With the Fed likely to assure investors that the current QE3 purchases will stay in place in coming months, traders and analysts said benchmark yields will likely bounce within a tight range, at least until the next non-farm payrolls report, due on Nov. 8. "This lends itself to a rangebound market," said Cullinane, who expects the 10-year yield to trade 2.45 to 2.65 percent in the near term. The government has released economic data that were delayed due to the shutdown after President Barack Obama and Congress reached a last-minute deal on Oct. 16 to temporarily fund federal spending and raise the debt ceiling through early 2014. U.S. factory output grew 0.6 percent in September, its largest monthly increase since February, the Fed reported on Monday. On the open market, 10-year Treasury notes were unchanged in price at 99-31/32 to yield 2.503 percent after falling as much as 7/32 with a yield of 2.537 percent. The 10-year yield touched a three-month low of 2.471 percent last week after disappointing September jobs figures. In "when-issued" activities, traders expected the forthcoming two-year note issue due in October 2015 was expected to clear at a yield of 0.3240 percent. This compared with a yield of 0.348 percent at the two-year auction held in September.
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