Investors expect the Federal Reserve to raise interest rates Wednesday, with markets pricing a 90% chance of a quarter-point increase under new Chair Kevin M. Warsh. However, bond investors remain anxious about the central bank's commitment to fighting inflation. If the Fed holds rates steady, investors may question its credibility, driving up long-term inflation expectations and roiling the government bond market. The 30-year Treasury yield is near a two-decade high, while the 10-year yield approaches a similar milestone, raising borrowing costs for mortgages and corporate loans.

Inflation pressures have surged since the U.S. attack on Iran in late February spiked oil prices. The 10-year break-even inflation rate stands at 2.4%, above the Fed's 2% target. Strategists like Subadra Rajappa of Societe Generale and Brendan Murphy of Insight Investment warn that a failure to hike could unanchor long-term expectations. "If they don't hike, the risk is that inflation expectations... start to rise," Murphy said.

Expectations have shifted dramatically under President Trump, who appointed Warsh to lower rates. Before the Iran strike, markets anticipated rate cuts; now they foresee up to four hikes through next year. Warsh's limited forward guidance has added uncertainty, though an August speech signaled willingness to act if inflation persists. August data showed continued price increases, pressuring Warsh to follow through.