Beware a premature return to 'normal'

(breakingviews.com) -- Forgiveness is wonderful. But if it is granted too soon, miscreants tend to go back to their wicked ways. Markets risk giving some parts of the financial system just such a premature pardon.

While the economic arrows are still mostly pointing downward, markets seem to be twisting the data in a positive direction. A few numbers suggest that a little bit of the exuberance of the go-go credit years could be returning.

The U.S. trade deficit rose to $28 billion in March, from $26 billion in February. The March number was still less than half last July's $63 billion peak. But this was the first monthly increase since then.

The oil price is main reason for the turn. Crude has jumped by 50% in less than three months, even though demand is still down and inventories are up. Commodity investors' cash seems to be playing a big role.

Bankers are definitely feeling friskier. Trading profits have been strong, share prices are up massively and more people see a return to sustainable double-digit returns on equity. Multi-million dollar banker bonuses no longer look like history.

If the situation holds, the momentum to reshape the global financial system - which was strong as recently as April's G20 meeting - will dissipate. The U.S. and U.K. could then go back to living well beyond their means, and the funds borrowed from their creditors could once more pump up financial markets. Bankers might be able to persuade politicians that the calls for tougher and better regulation were overdone.

Such a reversion might bring back happy days for a while. But the financial imbalances would still be unsustainable. Sooner or later, another boom would be followed by another bust.

And the next financial collapse could plausibly be worse than the one that might now be ending - hard as that may be to imagine. Even if deserting creditors did not cause a dollar rout, indebted governments and stretched central banks would be unable to offer much in the way of stimulus.

Investors may welcome the better financial mood now, but this is a pleasure that would be better off deferred. Vigilance is needed.