TREASURIES-Bonds rally; pass first auction test

* First of week's record bond auction slate goes well

* Fed policy statement Wednesday an event risk for market

* Weaker U.S. housing data helps safe-haven bonds (Updates after auction)

NEW YORK, June 23 - U.S. Treasury debt prices rose on Tuesday as the market repositioned itself a day ahead of the Federal Reserve's policy statement, gaining additional support from a strong kick-off to the week's record bond auctions.

The week's record $104 billion in supply issuance started with exceptionally strong demand for the $40 billion issue of two-year notes.

Overall demand, measured by the bid-to-cover ratio, hit its highest in nearly two years, while a key gauge of interest by foreigners and large institutional investors was nearly twice its usual average.

The bond auction came in the wake of data showing sales of previously-owned homes in the United States were weaker than expected in May, pointing to a sluggish recovery from the severe economic recession, which helped the debt market overcome some supply worries.

"It's a recognition of a stagnating economy," said Jessica Hoversen, fixed income market analyst at MF Global Research in Chicago.

"It's naive to wish a swift recovery given this unprecedented downturn. The consumer is still highly deleveraged and companies are reluctant to hire."

The benchmark 10-year Treasury note initially added to the day's gains after the sale but later gave some of that back. It was last up 4/32 in price, yielding 3.67 percent versus 3.69 percent at Monday's close.

The existing two-year notes last traded flat in price, yielding 1.13 percent.

The bid/cover ratio came in at 3.19 times the amount on offer, the highest since 3.29 in September 2007.

Indirect bidding, the widely used proxy for foreign and institutional demand, was about 68 percent, versus its historical average of around 35 percent.

The high yield at the auction also came in roughly five basis points below market expectations, reflected by trading in the when-issued market just before the sale. This was also a sign of a strong sale.

Investors also were anxiously awaiting the Federal Reserve's statement for hints to the central bank's thinking about the economic recovery expected later in the year, its $300 billion Treasury buying program and the eventual end of its super-easy monetary policy. The statement will be released after its two-day meeting, on Wednesday

Despite the focus on the Fed, the massive volume of Treasury supply will compete for investor's attention.

The Treasury's record volume of auctions this week are part of its enormous efforts to finance a rescue of the world's largest economy, with $2 trillion in new issuance expected this fiscal year.

The borrowing could ultimately swamp the market, though the shorter maturities in this week's supply bode well for the sales, analysts said, since holding them involves less uncertainty than longer-dated bonds.

One potential source of support for Treasuries came from Moody's Investors Service, which said on Tuesday that the U.S. government's credit rating of Aaa was safe.

Moody's added, however, that it could be at risk if Washington were unable to bring its public debt back to a downward trajectory.