Global Insight Inc. warns of the possibility of the Canadian dollar reaching parity with the U.S. greenback, in a new research note.

“While we deem the likelihood of the Canadian dollar reaching parity with the U.S. dollar to be low, such a scenario is no longer outlandish,” it says, adding, “Investors would be well advised to hedge their portfolios for this eventuality.”

The firm adds that if the Canadian dollar rose to parity over the next few years, the implications for markets would be completely different, depending on the reasons for the appreciation.

If it did so on the back of higher commodity prices, this “would open the floodgates on foreign wealth transfer to Canada, with benefits initially flowing to corporations and governments. Industries producing industrial materials such as metals, steel, and chemicals would see the largest output gains from the commodity price boom. The oil patch would also see improved output, albeit with some lag due to long lead times required to realize the oil-sands production potential.”

Alternatively, the move to parity could be of a more speculative nature that reflects factors such as concerns about the U.S. current-account deficit, expectations of dramatically higher commodity prices in the future, or, more generally, increased investor preferences for Canadian assets.

In that scenario, “The ill effects of the higher currency would be quickly felt in the export sector, depressing GDP growth to 2.7% this year and only 1.9% next. The worst-performing export sectors would include consumer goods (excluding autos) and machinery, which are the most vulnerable to foreign competition from lower cost locales,” it predicts. “Most of the economic pain would be unnecessary if the Bank of Canada eased credit conditions on time. Roughly speaking, this would require the bank to introduce 25-percentage-point interest rate cut for every 2-cent loonie appreciation of the speculative type.”

“If the parity scenario did play out, it would be most likely a mix between the two extreme cases of commodity-driven and speculation-based appreciation,” Global Insight suggests. “With the key Bank of Canada interest rate close to a neutral level, monetary policy would have plenty of room to ease credit conditions if the appreciation were caused mainly by speculative flows.”

“The general conclusions regarding the impact on export sectors in the two extreme cases are still valid in a more reasonable, between-extremes scenario: industrial materials and energy would do well, while consumer goods and machinery would have much harder time to adjust,” it says.