By John McCrank
TORONTO, Jan 4 (Reuters) - The Canadian dollar fell to a two-week low against the U.S. dollar on Friday, after data on domestic purchasing activity in December came in well below market expectations, adding to concerns that the U.S. economic slowdown is spilling over into Canada.
The weak data, along with softer than expected U.S. jobs numbers, pushed domestic bond prices higher.
The Canadian dollar closed at 99.87 U.S. cents, valuing each U.S. dollar at C$1.0013. That was down from US$1.0092, or 99.09 Canadian cents per U.S. dollar, at Thursday's close.
For the week, the Canadian dollar was down 2.1 percent, despite record prices for key commodities.
Both oil and gold hit record highs during the week, with U.S. crude prices CLc1 topping $100 a barrel and spot gold prices XAU= nearing $870 an ounce.
With Canada a major producer of both oil and gold, strong commodity prices have traditionally benefited the Canadian currency. But the worry now is on how much additional pressure those high prices will add to a faltering U.S. economy.
A significant slowdown in the United States, Canada's largest trading partner, would undoubtedly have a negative impact north of the border, said Camilla Sutton, currency strategist at Scotia Capital.
"We certainly see U.S. housing weakness, and we are seeing that flow into other areas of the economy, including some obvious softening in the labor market, and high energy prices could very well be the tipping point that throws the U.S. economy ... into much harder times."
A surprisingly weak U.S. jobs report further stoked fears of a U.S. recession.
"The only time in the past 25 years that the unemployment rate has increased by this much in a month was in the past two recessions," BNP Paribas economist Brian Fabbri said in a note.
"Thus, the probability that the U.S. economy is on the verge of recession, or could already be entering one, has risen significantly."
Concerns that the slowdown in the U.S. could spill over into Canada were amplified by data showing Canadian purchasing activity fell to its lowest point since December 2001.
"The market was already thinking that growth slowdown in the U.S. should provide growth slowdown in Canada, and I think that the timing of the number, even though it is really second-tier data, really just provided confirmation of that," said Sutton.
The Ivey Purchasing Managers Index fell to 45.9 in December from 58.7 in November, indicating activity contracted for the first time since December 2006.
Bond prices rallied along with U.S. treasuries on the weak U.S. jobs numbers, and were pushed higher by the Ivey data.
The bad news about the U.S. economy has investors betting that the Federal Reserve will be forced to cut interest rates aggressively to prevent a recession, driving up bond prices.
But the rally in bonds may not last, said Eric Lascelles, chief economics and rates specialist at TD Securities, who said that if there is a U.S. recession it will be a mild one.
"We've seen the Libor spread in the U.S. come down quite nicely in the last month, and we've seen commercial paper spreads narrow generously in Canada, so if we see that continue, the flight to safety unwinds, and you end up with quite a few arguments for higher yields."
The two-year bond rose 9 Canadian cents to C$101.25 to yield 3.560 percent. The 10-year bond was up 24 Canadian cents at C$100.81 to yield 3.896 percent.
The yield spread between the two-year and 10-year bond was 33.6 basis points, up from 31.4 at the previous close.
The 30-year bond rose 1 Canadian cent to C$115.92 to yield 4.067 percent. In the United States, the 30-year treasury yielded 4.379 percent.
The three-month when-issued T-bill yielded 3.78 percent, down from 3.81 at the previous close. (Editing by Rob Wilson)