FX Vol Insight: Four rotations, one framework for FX Vol

Research evidence excerpt

FX Vol Insight: Four rotations, one framework for FX Vol

cates that the most important

drivers are the JPY and Scandinavian volatility complexes.

Clustering analysis supports our interpretation

While the PCA loadings suggest a high-beta versus low-beta volatility rotation, it

remains important to verify whether this structure is present in the underlying volatility

data. To do so, we applied a hierarchical clustering framework to vol changes after

removing the contribution of PC1.

This step is important because PC1 explains 80%+ of total variance and dominates the

raw correlation matrix. As a result, most volatility series appear highly correlated simply

because they are exposed to the same global vol shocks. Removing PC1 allows us to

isolate the residual relationships between currency pairs and determine whether the

rotation implied by PC2 is visible in the data itself. In other words: (1) PCA identifies the

factor; while (2) residual clustering tests whether that factor corresponds to

economically meaningful groups.

The residual clustering results (Exhibit 2) reveal four distinct blocks:

• JPY / Low-Beta Volatility Cluster (USDJPY, EURJPY, AUDJPY, NZDJPY & CADJPY).

These pairs all share a common JPY volatility driver and form the most coherent

cluster in the residual correlation matrix. This cluster represents the defensive or

funding-volatility side of the PC2 factor.

• Commodity / High-Beta Volatility Cluster (AUDUSD, NZDUSD, EURAUD,

EURNZD, AUDNZD & AUDCAD). These pairs are linked by exposure to AUD and NZD

volatility and represent the cyclical or high-beta side of the factor. The emergence

of this cluster provides independent evidence that a high-beta volatility complex

exists within the FX options market.

FX Vol Insight | 14 July 2026 3

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