* Canadian dollar weakens against rallying U.S. dollar
* Its decline reaches 1.5 percent over two sessions
* Bonds rebound on U.S. avian bird flu scare
By Frank Pingue
TORONTO, June 3 (Reuters) - The Canadian dollar fell nearly 1 percent on Tuesday against a U.S. dollar that rallied after comments from the head of the Federal Reserve that bolstered the view that the Fed may raise U.S. interest rates this year.
Domestic bond prices rebounded from losses suffered early in the session and closed mostly higher across the curve as bird flu news out of the United States and financial jitters sparked demand for more secure assets.
The Canadian dollar closed at C$1.0086 to the U.S. dollar, or 99.15 U.S. cents, down from C$1.0012 to the U.S. dollar, or 99.88 U.S. cents, at Monday's close.
After snapping a three-week streak of gains last week, the Canadian currency has pushed lower, including a 0.8 percent decline on Monday and 0.7 percent drop on Tuesday.
The latest decline was pegged to the U.S. dollar's strength, rather than anything specific to Canada. Fed Chairman Ben Bernanke, in an address to a conference in Barcelona, warned about the inflationary impact of a weak currency, suggesting the central bank may raise rates to support the dollar and staunch any inflationary pressure.
"There's one event that's pretty much driven the Canadian dollar and that's the Bernanke comments," said Stewart Hall, market strategist at HSBC Securities. "He certainly grabbed the attention of currency markets and caused a fairly broad-based (U.S.) dollar rally,"
The Fed has slashed its benchmark overnight lending rate by 3.25 percentage points since mid-September. The Bank of Canada has lowered its key rate 1.50 percentage points to 3.00 percent since the start of December and is expected to cut another 25 basis points on June 10.
Another drag on commodity-linked Canadian dollar were the growing concerns about slowing global growth and how that could weaken prices for the commodities that Canada exports. Oil prices have steadily fallen from a record above $135 a barrel reached last month.
The Canadian dollar spent the North American session in a range of US$1.0045, valuing a U.S. dollar at 99.55 Canadian cents, and C$1.0097 to the U.S. dollar, or 99.04 U.S. cents, which marked its lowest in nearly a month.
BOND PRICES REBOUND
Canadian bond prices recouped early losses thanks to an avian bird flu scare at the second-largest U.S. chicken producer, and a report that Lehman Brothers Holdings Inc had to borrow directly from the Fed via the discount window.
Tyson Foods Inc said it would have to get rid of about 15,000 chickens exposed to a mild strain of bird flu that had no risk to human health. But the news sent a shiver through financial markets and raised a bid for safe-haven government bonds.
Lehman eventually denied that it has borrowed money from the Fed recently and said it finished the second quarter well above $40 billion in liquidity. Still, the speculation rekindled memories of the collapse of Bear Stearns earlier this year.
"The initial negative tone in in bond markets was on Bernanke's comments that appear to suggest that the Fed was through (cutting rates)," said Mark Chandler, fixed income strategist at RBC Capital Markets.
"But later on, concerns about the brokerage liquidity in the U.S., and also warnings of bird flu in the U.S., really dictated things."
The move in bond prices was also held in check ahead of May employment reports for Canada and the United States on Friday.
The two-year bond rose 11 Canadian cents to C$101.76 to yield 2.833 percent. The 10-year bond ended up 7 Canadian cents at C$102.85 to yield 3.625 percent.
The yield spread between the two-year and 10-year bond was 79.2 basis points, up from 73.8 at the previous close.
The 30-year bond fell 12 Canadian cents to C$115.28 for a yield of 4.095 percent. In the United States, the 30-year treasury yielded 4.623 percent.
The three-month when-issued T-bill yielded 2.58 percent, down from 2.63 percent at the previous close. (Editing by Frank McGurty)