* U.S. Treasury to sell $32 billion two-year notes
* Smallest monthly two-year auction in over five years
* Fed to buy $4.25-$5.25 billion bonds due 2017-2018
NEW YORK, Oct 28 (Reuters) - U.S. Treasuries prices fell 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. 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 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 in a bid 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 policy-makers will meet on Tuesday and Wednesday after 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 rally in the bond market, helping to send the 10-year yield down some 50 basis points from a 25-month high of 3 percent. At 11 a.m. (1500 GMT), the Fed was scheduled to buy $4.25 billion to $5.25 billion of Treasuries that mature from Oct. 2017 to June 2018. With the Fed likely to assure investors that the current QE3 purchases will stay in place in the coming months, traders and analysts said benchmark yields will likely bounce within a tight range at least until the next non-farm payrolls report, which will be 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 traded down 4/32 in price with a yield of 2.520 percent, up nearly 2 basis points from late on Friday. 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.