The weakening U.S. dollar likely means a tougher time for the Canadian economy, but it will also keep interest rates low, benefiting interest-sensitive stocks, according to new report released today by CIBC World Markets Inc.

“Canada’s economy is about to be put through a test, the likes of which it has never seen,” write economists Avery Shenfeld and Peter Buchanan in the report. “At no time during its 30-year history of floating exchange rates has the Canadian dollar seen as rapid and extensive an appreciation as has taken place in the past two years.”

The pair warns that underlying the health of total exports are signs of impending illness, “and the damage to be done to Canadian non-resource manufacturers will be no less telling, and longer-lived than in the early 1990s.” Canada’s real trade deficit in non-resource goods has been widening, the report notes, amd margins are under pressure.

Corporate profits are also being affected, the report says. “Non-resource manufacturers in the TSX Composite have significantly lagged resource producers and services firms in return on equity. Returns in TSX non-resource manufacturers have also lagged those for the S&P 500 by 15%-pts in recent years. Sub-par returns will translate into slowdowns in production and hiring in the coming quarters, and, longer term, into downsizing or relocation decisions,” Shenfeld and Buchanan write.

“As a result of the impending hit from a firm Canadian dollar, our strategy recommends underweights in industrials and export-related consumer discretionary stocks. We’ve overweighted telecoms and consumer staples in part because these sectors benefit from lower costs for imported equipment or goods for sale,” they conclude. “And look for the Bank of Canada to judge a 77 to 80-cent exchange rate as a key substitute for interest rate hikes next year, of benefit to fixed income markets and interest-sensitive equities and income trusts.”