TREASURIES-Bonds rally on weak economy, Fed fixed-income buys

* Boosted by data confirming U.S. economy contracting

* Fed aid program for mortgages boosts array of bonds

* Five-year auction awaited (Adds comments, updates prices, recasts first paragraph)

By John Parry

NEW YORK, Nov 25 (Reuters) - U.S. Treasury debt prices rallied on Tuesday on the weakening economy, ebbing inflation and the ripple effects on bond markets of a Federal Reserve plan to directly buy mortgage-related fixed income assets.

Treasuries surged after government data confirmed the economy contracted and inflation pressures eased in the third quarter, reinforcing the impression a recession is under way.

Investors have been flocking to the safety of government securities as the economic warning signs flash red in the fourth quarter: U.S. home prices continue to fall and consumer spending drops as the worst lending crunch in decades takes its toll.

The benchmark 10-year note yield fell back within sight of its 2.99 percent five-decade low hit last week.

The benchmark 10-year Treasury note's price, which moves inversely to its yield, climbed 1-23/32 for a yield of 3.13 percent US10YT=RR, versus 3.33 percent late Monday.

In addition, the Fed's announcement that it would buy mortgage-related assets drove the prices of these assets higher, simultaneously lifting the price of longer-dated government bonds, said Sean Murphy, Treasury trader with RBC Capital Markets in New York.

The Federal Reserve said it would buy housing-related securities with a $600 billion program and also set up a $200 billion facility to buy consumer debt securities.

"The Fed is buying mortgages on an outright basis. They are buying fixed income so it supports the bond markets generally, not just mortgages," said Carl Lantz, U.S. interest rate strategist with Credit Suisse in New York. That was helping Treasuries rally on Tuesday, he said.

"They are going to be buying mortgages from dealers who would have been short a Treasury as a duration hedge. Then the dealer buys back the Treasury and so covers his hedge," said Lantz.

When market participants "short" an asset they bet that its price will decline, adding to selling pressure in that asset. When market short positions are reversed, that tends to buoy the price of those assets.

Over the longer term, the Fed steps should help unblock credit markets which would diminish the appeal of safe-haven U.S. government securities, analysts said.

"Here is the Fed taking a bunch of debt out of the market, which doesn't hurt. I think it should it should help unblock the credit markets," said Scott Brown, chief economist with Raymond James & Associates in St Petersburg, Florida. "There may be less of a flight to safety in Treasuries," he added.