By John McCrank
TORONTO, Jan 21 (Reuters) - The Canadian dollar closed at a four-month low against the U.S. dollar on Monday as stock markets around the world sank in response to fears of a U.S. recession, darkening the outlook for Canadian exports.
Canadian bond prices rallied on the equities selloff ahead of what is widely expected to be a Bank of Canada interest rate cut on Tuesday.
The Canadian dollar closed at 96.81 U.S. cents, valuing a U.S. dollar at C$1.0329, down from 97.33 U.S. cents, or C$1.0274, at Friday's close.
"With about 75 percent of Canadian exports destined for the U.S., a significant slowdown in growth south of the border will inevitably leave its mark on Canadian export performance, and hence GDP growth," said Jacqui Douglas, economics strategist at TD Securities, in a note.
That sentiment was echoed on the Toronto Stock Exchange, which shed more than 600 points on its way to its biggest one-day drop in seven years.
U.S. markets were closed for the Martin Luther King Jr. Day holiday, creating illiquid conditions and amplifying Toronto stock market moves, as well those as in Asia and Europe.
After a stellar 17.5 percent rise versus the greenback in 2007, the Canadian dollar has fallen 4 percent as concerns grow about what impact a global slowdown could have on Canada given the nature of its exports.
Canada is a producer and exporter of many key commodities, such as oil, gold, and base metals.
U.S. crude oil slid to a six-week low below $89 a barrel on Monday due to the outlook in the United States, which is the world's top energy consumer.
Another factor in the decline of the Canadian dollar has been a recent raft of data that has missed market expectations.
That data, and the softening North American outlook, will likely play a large role when the Bank of Canada sets interest rates on Tuesday.
Canada's 12 primary security dealers see the central bank cutting its key overnight rate by 25 basis points, according to a Reuters poll on Thursday. But the recent distress in the equities markets has some market players now calling for a 50 point interest rate cut, said Steve Butler, director of foreign exchange at Scotia Capital.
Also of note this week will be the Bank of Canada's Monetary Policy Report Update due on Thursday, which will likely include updated forecasts for growth and inflation.
Canadian bond prices rallied as investors sought secure assets in response to the carnage in the stock market.
"Everything is being driven off stocks," said Carlos Leitao, chief economist at Laurentian Bank of Canada.
The bond market will likely stay fairly volatile until at least the end of the month, when the U.S. Federal Reserve is expected to cut interest rates by 50 to 75 basis points, he said.
Preliminary U.S. fourth-quarter gross domestic product numbers will also be released at the end of the month, and a positive reading could help settle some nerves.
On the Canadian data front, wholesale trade rose 0.3 percent in November, missing the median forecast of analysts in a Reuters poll looking for a 0.5 percent gain.
The two-year bond was up 22 Canadian cents at C$102.07 to yield 3.093 percent. The 10-year bond rose 30 Canadian cents to C$101.99 to yield 3.745 percent.
The yield spread between the two-year and 10-year bond was 65.2 basis points, up from 57.4 basis points at the previous close.
The 30-year bond increased 6 Canadian cents to C$115.90 to yield 4.067 percent. In the United States, the 30-year Treasury yielded 4.284 percent.
The three-month when-issued T-bill yielded 3.54 percent, down from 3.61 percent at the previous close.