* C$ closes at C$0.9789 to the U.S. dollar, or $1.0216
* Rises more than 2 cents after easing to parity overnight
* Bonds prices mixed, underperform Treasuries
* Fed promises to keep rates low for at least 2 yrs
* Markets price in at least one Canada rate cut by yr-end (Adds analyst comment. Updates to close)
By Ka Yan Ng
TORONTO, Aug 9 (Reuters) - Canada's dollar rallied in highly volatile trade against the U.S. currency on Tuesday, climbing more than 2 cents from its session low, after the U.S. Federal Reserve pledged to keep its hefty monetary policy stimulus for at least another two years.
The rise mirrored a rally in North American stock markets that drove the Toronto Stock Exchange's S&P/TSX composite index .GSPTSE up 3.76 percent to its biggest one-day rally in more than two years. [MKTS/GLOB]
"The Fed has given a very clear signal that (what) was once an extended period is actually far more significant," said David Tulk, chief Canada macro strategist at TD Securities.
"It has also helped to close the book on quantitative easing as the Fed will likely adhere to the theory of lower for longer as opposed to conduct(ing) additional asset purchases."
The Fed's decision -- divided, as three members voted against the move -- followed three sessions of financial markets turmoil driven by worries about another U.S. recession following an embarrassing downgrade of U.S. debt.
Canada's currency CAD=D4 hit a session high of C$0.9772 to the U.S. dollar, or $1.0233. Much earlier in the session it had weakened to parity with the U.S. dollar for the first time since February.
Immediately after the Fed statement it hit a session high, weakened off, then resumed its climb, mirroring the wide swings in North American stock markets.
"The market is extremely volatile. It indicates to me that a lot of people are unsure of what to do," said John Curran, senior vice president at CanadianForex.
The Canadian dollar CAD=D4 ended the the session at C$0.9789 to the U.S. dollar, or $1.0216, up steeply from Monday's North American session close at C$0.9909 to the U.S. dollar, or $1.0092. It was only the third up day in the past 10 sessions.
Bond markets were also volatile and ended mixed. Canada's two-year bond CA2YT=RR fell 9 Canadian cents to yield 0.847 percent, while the 10-year bond CA10YT=RR gained 30 Canadian cents to yield 2.453 percent. Canadian government bonds mostly lagged the gains seen in Treasury prices. [US/]
BOC RATE CUT PRICED IN
Analysts said the possibility that the Fed will hold interest rates lower for longer may also mean the Bank of Canada will have to tread a similar path since the two economies are so closely linked.
In the Canadian overnight index swaps market, which is based on expectations for the Bank of Canada's key policy rate, traders fully repriced the prospect of a rate cut later this year after backing off the idea when markets had been rallying early in the day. BOCWATCH
"That's being priced out of panic as opposed to rationality," said Tulk, who remained comfortable with his forecast that the Bank of Canada will raise interest rates early next year.
"Recognizing the linkages between Canada and the U.S., I think the Bank of Canada has to take into account -- unless they want to send the currency to the stratosphere -- they need to be appreciative of the downside risk that they had once feared are now becoming realized." (Editing by Jeffrey Hodgson)