* Prices gain on fears over Cyprus contagion * Bond rally squeezes shorts, prompts short covering * Fed to buy $2.75-$3.50 bln in notes due 2020-2023 By Karen Brettell NEW YORK, March 19 (Reuters) - U.S. Treasuries prices edged up for a second day on Tuesday as investors were unsettled by a bailout deal in Cyprus that either risks a bank run from a proposed tax on depositors or the country's default if the proposal falls through. A government spokesman said Cyprus's parliament was likely to reject plans agreed by euro zone officials over the weekend to part-fund a 10 billion euro rescue of the island by seizing between 6.75 percent and 9.9 percent of deposits in Cypriot banks. 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 Guggengeim Partners in New York. Investors that were positioned for further increases in Treasuries in yields as economic data improves have also been caught off guard by the news, and have had to cover shorts, which has added to the bond rally. "Cyprus killed any move to higher yields as of right now," Rogan said. Benchmark 10-year notes were last up 6/32 in price to yield 1.94 percent, down from 1.96 percent late on Monday. Thirty-year bonds gained 8/32 in price to yield 3.17 percent, down from 3.18 percent. Volumes fell on Tuesday after a surge in trading early on Monday in reaction to the Cyrpus news. Investors are also focused on a Federal Reserve meeting on Tuesday and Wednesday, watching for any signs of when Fed Chairman Ben Bernanke may consider tapering or ending bond purchases, after recent data pointed to an improving U.S. economy. Most Wall Street economists expect that 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 their economic prospects may give the Fed further reason to continue its bond purchases, traders said. The Fed will purchase between $2.75 billion and $3.50 billion in notes due 2020 and 2023 on Tuesday as part of its ongoing purchase program.