Investors are awaiting a crucial inflation report to gauge how long the Federal Reserve, under the potential leadership of Kevin Warsh, can afford to stay on hold amid persistent high oil prices driven by Middle East tensions. As conflict between the U.S. and Iran around the Strait of Hormuz threatens to break a month-long ceasefire, the bond market is feeling the impact of oil price volatility. The yield on the 30-year U.S. Treasury note briefly touched 5.03% last week, hitting its highest level since July. Since the outbreak of conflict in late February, traders have not only priced out expectations for Fed rate cuts but have also begun betting that Warsh—who is expected to succeed Jerome Powell as Fed chair when his term ends this week—may need to raise rates next year. Interest rate swaps indicate traders see about a one-third probability of a rate hike by April 2027. A growing number of Fed officials have hinted that the next policy move could be either a rate cut or a hike. The risk is that strong inflation data, against a backdrop of a stable labor market and easing financial conditions, could fuel expectations of further price increases and force the central bank to act. Economists expect the inflation report to show the Consumer Price Index (CPI) rose 3.7% year-over-year in April, the largest increase since 2023. The core CPI, which excludes food and energy prices, is forecast to rise 2.7%, the highest since September. The bond market is "driven by expectations that inflation will move higher," noted Ruben Hovhannisyan, a fixed income portfolio manager at TCW Group. However, he added that he remains bullish on bonds, as the inflationary impact of higher oil prices may be temporary, and cooling in the labor market could prompt the Fed to restart rate cuts later this year. Aside from the inflation report, this week's auctions of 3-year, 10-year, and 30-year U.S. Treasury notes will also test investor appetite.