Bond yields rose and stocks slumped after an unexpected rise in consumer inflation to its fastest pace in a year, making it more likely the Fed will raise interest rates three or more times this year.

At the same time, January retail sales fell unexpectedly in their biggest drop since last February, declining 0.3 percent, raising new concerns about the economy. That is likely to prompt lower expectations for first quarter GDP growth.

"You have to worry about more inflation, worry more about the Fed," said Michael Schumacher, director of rate strategy at Wells Fargo. He said the fed funds futures market reflects a slightly higher expectation for interest rates — with just over 2.6 hikes now factored in, after the consumer price index data, from 2.5 prior to the report.

The CPI rose 0.5 percent, or 2.1 percent year over year, higher than the 0.3 percent increase expected. The core CPI, excluding food and energy, rose 0.3 percent, compared with the expected 0.2 percent increase. That puts core inflation at a pace of 1.8 percent year over year.

Stock futures erased sharp gains and plunged, with the Dow opening down triple digits, after the 8:30 a.m. ET data. The which reflects Fed policy, jumped to 2.15 percent, while the 10-year rose to 2.88 percent.

"This is muscular. The CPI is just very solid and the fact that the year over year is stable is impressive. Given ... the comparisons of last year, … this is a pretty compelling inflation reading," said Ward McCarthy, chief financial economist at Jefferies.

Traders said the weak retail sales reading contained what could have a much sharper move in interest rates.

"Retail sales are weak, quite frankly. ... That suggests consumer spending is going to be substantially lower than it was in Q4," said McCarthy.

The dollar rose against currencies after the report.

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