I think you've got a very clever bit of storytelling, mindscrewy timey-wimery stuff going here, but because of the nature of tabletop games it's gonna be hard to pull it off right.
The key is for the players to only think 'oh crap, we just got butchered' for a few minutes of realtime, just enough to feel shocked but not enough to start getting pissed off, before you have them 'wake up' alive and well ...prior to the fatal battle.
But don't just do 'it was a dream' straight.
1. Have there be some foreshadowing before the prologue fight, as they're running in have them catch a brief staticky glimpse of the mystery creature doing the timescrewy, or have a time skip glitch, or both.
2. If it looks like the fight's dragging on or the players are getting upset, end the fight with the hag's super-attack going off, fire everywhere, more time-scritchery, BOOM everyone blacks out.
3. Don't have them 'wake up' in a normal place. Especially not their beds. Have them either snap out of it while they're in the middle of some other mundane task or have them wake up somewhere they shouldn't be, like someone else's house, or a ditch beside a road outside the village, or on the roof of the tavern. Something that makes them go 'wtf just happened'.
4. Keep throwing those little glitches and time-spacks through the ensuing day, little hints building up as you drop the clues.