TORONTO (Reuters) - The Canadian dollar fell against the U.S. dollar on Tuesday due to soft commodity prices, but managed to make up some ground late in the session as markets cheered a report of a possible bailout for troubled insurer American International Group (AIG.N).
Canadian bond prices tumbled lower along with the larger U.S. market after the U.S. Federal Reserve held interest rates steady, and the AIG report surfaced.
The Canadian dollar ended the North American session at C$1.0695 to the U.S. dollar, or 93.50 U.S. cents, down from C$1.0679 to the U.S. dollar, or 93.64 U.S. cents, at Monday's close.
The currency hit a weak point of C$1.0750, or 93.02 U.S. cents, as commodity prices dropped on concerns that the global credit crunch and recent market turbulence would cut into demand.
Commodities make up about half of Canada's exports, and movements in the prices of oil, gold, base metals, and natural gas can influence the direction of Canada's currency.
The latest crisis in the global financial system was sparked by Lehman Brothers Holdings Inc's LEH.N bankruptcy protection filing on Monday.
The sale of investment firm Merrill Lynch MER.N increased the market concern, and AIG's inability to find cash heightened it to a fever pitch.
Late in the session, however, a report that U.S. authorities were considering a loan package for AIG buoyed markets.
"We saw some risk appetite returning," said Matthew Strauss, senior currency strategist at RBC Capital Markets.
"It filtered through equities, it filtered to the currency market... and as it filtered through ever so slightly on the commodity side, it supported the Canadian dollar."
Canadian bonds fell along with the U.S. market, giving back a big chunk of the gains from Monday's big rally.
"You can attribute that to the Fed pausing... and simultaneously, these rumors that AIG could be bailed out by the (U.S.) federal government," said Eric Lascelles, chief economics and rates strategist at TD Securities.
Many in the market had speculated the Fed would cut interest rates to soothe the nerves of investors, and the bond market had started pricing in an easing to reflect those expectations.
When the Fed held rates steady, saying that inflation still had to be taken into consideration, the bond market unwound.
At the same time, stock prices rallied on the AIG report, undercutting the safe-haven bid that had supported bonds.
On the data front, figures showed Canadian manufacturing sales rose more than twice as fast as expected in July. Shipments were up 2.7 percent from June due to broad-based strength led by the durable goods industries.
The two-year bond fell 41 Canadian cents to C$100.25 to yield 2.632 percent, while the 10-year dropped 80 Canadian cents to C$106.35 to yield 3.472 percent.
The yield spread between the two-year and 10-year bond was 85.8 basis points, down from 101 basis points at the previous close.
The 30-year bond shed C$1.15 to C$117.55 for a yield of 3.969 percent. In the United States, the 30-year Treasury yielded 4.127 percent.
The three-month when-issued T-bill yielded 2.15 percent, down from 2.25 percent at the previous close.
Editing by Peter Galloway