If predatory wolves comes during setup and you choose to discard the highest cost ally you control and you control the objective ally and no other allies would Amarthiul get discarded in an instant loss? I was confused because the second quest card makes objective allies immune from this effect but perhaps the treachery is not the free break during setup I thought it was.

For context, the card states:

When Revealed: Each player must choose: either discard the highest cost ally he controls, or search the encounter deck and discard pile for a Warg enemy, reveal it, and add it to the staging area. Shuffle the encounter deck.

So nothing is stopping you opting for the instant loss option, however it's not forced upon you since the card follows the "X or Y" format. Therefore, you are always free to select the option to reveal a Warg enemy.