TREASURIES-Prices gain after slightly dovish Fed statement

(Updates one-month bill yields, paragraphs 2, 11)

* Fed dovish on inflation, hints at balance sheet reduction

* Treasury sells $34 bln five-year notes to strong demand

* Three-month T-bill yields elevated on debt ceiling

concerns

By Karen Brettell

NEW YORK, July 26 (Reuters) - U.S. Treasury prices gained on

Wednesday after the Federal Reserve indicated that it is likely

to begin paring its balance sheet in the coming months and

struck a slightly dovish tone on inflation.

The U.S. Treasury yield curve also marked a milestone not

seen since the onset of the financial crisis, with all

maturities comprising the curve sporting a yield of at least 1

percent for the first time in nearly nine years.

The U.S. central bank said it expected to start winding down

its massive holdings of bonds "relatively soon." It also noted

that both overall inflation and a measure of underlying price

gains had declined and said it would "carefully monitor" price

trends.

“They were very balanced,” said Aaron Kohli, an interest

rate strategist at BMO Capital Markets in New York. “They

acknowledged inflation weakness, which was the dovish part of

the statement, and they also kept a fairly tight leash on the

market by basically implying that they are ready to taper

relatively soon.”

Many analysts and traders expect the Fed to announce its

balance sheet reduction plans at its September meeting.

Futures traders are pricing in a 50-percent chance that the

Fed will raise rates at its December meeting, down from 52

percent before the statement, according to the CME Group (Kuala Lumpur: 7018.KL - news) 's

FedWatch Tool.

Benchmark 10-year notes gained 11/32 in price to

yield 2.29 percent, down from 2.33 percent on Tuesday.

The Treasury Department sold $34 billion in five-year notes

to solid demand on Wednesday, the second sale of $88 billion in

new coupon-bearing supply this week. A $26 billion sale of

two-year notes on Tuesday was also well bid.

Fund managers, foreign central banks and other indirect

bidders took their biggest share at five-year government note

auction in seven months.

The United States will also sell $28 billion in seven-year

notes on Thursday.

Yields on one-month Treasury bills ended at 1.002

percent, marking the first time since before Lehman Brothers

collapsed in September 2008 that the entire U.S. yield curve has

yielded over 1 percent.

Yields on three-month Treasury bills that are due

in October were also elevated on concerns that payments on debt

due in the month will be delayed if Congress fails to raise the

debt ceiling.

The Congressional Budget Office said last month that

Congress would need to increase the debt limit by early to

mid-October to avoid a default.

Yields on Treasury bills that mature on Oct (Shenzhen: 000069.SZ - news) . 26

last traded at 1.14 percent after rising to 1.20 percent on

Tuesday, the highest level since October 2008.

(Editing by Lisa Shumaker and David Gregorio)

)