Is QBE Insurance Group Ltd a buy?

Overnight, the Federal Reserve left interest rates unchanged in the United States, citing sluggish inflation as an impediment to a rate rise at present time. Nevertheless, the Federal Reserve’s comments indicate optimism towards the long-term outlook for inflation, implying a rate rise may be just around the corner.

If this were to occur, I believe QBE Insurance Group Ltd (ASX: QBE) is one stock which would make the most of favourable interest rate tailwinds. Here’s why.

The decision

The Federal Reserve has indicated on countless occasions that it will only lift interest rates if the U.S. economy is strong enough to withstand a rate rise. Similar to Australia’s Reserve Bank of Australia, the Federal Reserve uses a target inflation rate (of 2%) to determine the adequate monetary policy of America.

Last night, the Federal Reserve deemed growth was subdued, opting to leave the rate unchanged. However, comments around positive inflationary signals suggest a rate rise may occur as early as June, pushing the U.S. dollar higher as a result.

Impacts of a rate rise

Interest rates have a profound effect on a nation’s currency given demand for its currency will be determined by the interest rate returns on offer. When the Federal Reserve decides to lift interest rates, demand for the U.S. dollar increases, pushing the price of its currency higher (as more people want to invest in America).

A rate rise is therefore detrimental to companies which rely on a weak U.S. dollar for their operations, such as Flight Centre Travel Group Ltd (ASX: FLT) and Harvey Norman Holdings Limited (ASX: HVN) which benefit when the Australian dollar buys more in U.S. dollar terms. However, for every loser on the S&P/ASX 200 Index (ASX:XJO) there are equal winners.

Businesses which have a substantial presence in the United States or ‘export’ their products in U.S. dollar terms are likely to benefit from a strong U.S. dollar due to currency gains; companies like Ardent Leisure Group (ASX:AAD), BHP Billiton Limited (ASX: BHP) and CSL Limited (ASX: CSL) are but a few which spring to mind.

Why QBE?

I believe QBE is the best way to play a rate rise in America because of its business operations. The group has rejuvenated itself following years of profit downgrades, and is leveraged to the American economy. Additionally, QBE reinvests its earnings in U.S. government bonds meaning an increase in rates by the Federal Reserve would see QBE benefit on these deposits.

Group momentum

In its 2015 full year results, QBE reported 33.5% of its gross written premiums came from North America, indicating that a substantial chunk of its earnings are in U.S. dollars. The group returned to profitability in the region as well, declaring a $300 million profit in its North American underwriting operations.

Alongside its robust performance in other divisions, QBE announced a 9% increase to cash profit after tax and announced an intention to lift its dividend payout ratio in future years, implying higher returns for shareholders.

Foolish takeaway

QBE appears to be gaining momentum at a time which coincides with an interest rate rise in America. If events turn out as planned, it is likely that the group will declare strong results going forward, making today’s price relatively cheap for its potential.

Of course, adverse natural disasters or further write-downs could affect profitability, leaving it not immune to downside risks. Accordingly, investors must weigh up these risks before deciding to invest in QBE.

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Motley Fool contributor Rachit Dudhwala owns shares of QBE Insurance Group Ltd.. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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