The worst week in 2023 for stocks and bonds saw investors coming to the grips with the idea that the Federal Reserve may indeed have to keep rates higher for longer as it wages a war against inflation.

Wall Street has ramped up bets on the Fed’s peak rate to around 5.2%, from under 5% earlier this month, amid a barrage of hawkish remarks from US officials that followed a hot jobs print. And that’s not all. Traders who had been positioning for the central bank to hike only once more — in March — are suddenly being confronted with wagers on at least three more increases.

That’s why Tuesday’s consumer price index is seen as a litmus test for the Fed’s ability to thwart inflation amid the most-aggressive tightening cycle in decades. Core CPI will either point to the need to push further into restrictive territory or reflect the progress policymakers have made toward securing the anchor of inflation expectations, said Ian Lyngen at BMO Capital Markets.

“The new year’s bullishness has quickly faded as investors recalibrated forward expectations in the wake of the employment report,” Lyngen added. “As it presently stands, investors are biased for an upside surprise versus the consensus for core-CPI of +0.4% on a monthly basis.”

The S&P 500 rose 0.2% Friday. Weakness in tech stocks pulled the Nasdaq composite down 0.6% while the Dow closed 0.5% higher.

Treasury 10-year yields climbed to around 3.75%. Interest-rate options activity Friday included a large, apparently new position that will profit if the rate reaches 4% within a week’s time. The rise in yields weighed heavily on the tech space, with the Nasdaq 100 underperforming major gauges. The S&P 500 ended with a small gain Friday — but posted its worst week since December.

“It’s healthy to have these corrections along the way,” said Alec Young, chief investment strategist at MAPsignals. “Expectations are much more realistic about the Fed.”

After an indiscriminate risk rally that defied Fed hawkishness, sober-minded traders are upping their hedging game at long last.

The cost of contracts protecting against a 10% decline in the largest exchange-traded fund tracking the S&P 500 is now 1.7 times more than options that profit from a 10% rally. This so-called put-to-call skew is hovering at the highest level since August 2022, when a two-month rally abruptly reversed.Meantime, global equity funds had outflows of $7.4 billion in the week through Feb. 8, according to a Bank of America note that cited EPFR Global data. Cash funds also saw redemptions at $10.1 billion, while $7.4 billion entered bonds.

In corporate news, Lyft tumbled the most on record after forecasting dramatically lower profits than expected and saying it will cut prices in an attempt to attract and keep customers. Expedia Group executives gave an optimistic outlook for travel demand in the current quarter, reassuring investors after the company’s fourth-quarter results were weaker than expected.

America’s largest banks are unlikely to return share buybacks to prior levels anytime soon given tougher-than-usual Fed stress tests, according to Wells Fargo analyst Mike Mayo. The assumptions in this year’s test, published by the Fed on Thursday, “seem tougher, and they are made so as the economy nears a recession,” he said.

Traders also kept an eye on the latest geopolitical developments.

President Joe Biden ordered the Pentagon to shoot down an object spotted at 40,000 feet over Alaska less than a week after fighter jets targeted an alleged Chinese surveillance balloon that had crossed the US and provoked a national uproar.

Elsewhere, oil gained as Russia plans to cut its oil output by 500,000 barrels a day next month, following through on a threat to retaliate against western energy sanctions and sending oil prices sharply higher.

The yen strengthened as much as 1.4% against the dollar after news reports that Kazuo Ueda would be picked to become the Bank of Japan’s next governor. Investors initially interpreted the decision as likely a hawkish choice. Those gains were trimmed after Ueda spoke to reporters and said the BOJ’s stimulus should stay in place.

“Why do we care? Because the BOJ is locked into ultra-dovish policy,” said Chris Low at FHN Financial. “It is the only major central bank fighting to keep inflation high rather than trying to lower it. Now we’ll have to see how long he sticks to the old policy.”