Congress seems likely to raise or suspend the U.S. debt limit—but not without potential market volatility along the way.

A year ago, the Bipartisan Budget Act of 2019 suspended the U.S debt limit. However, the suspension ended on July 31, 2021, leaving total outstanding U.S. debt at its statutory maximum of approximately $28.4 trillion. To avoid a government default, Congress needs to again raise or suspend the debt limit before the Treasury runs out of money.

Without issuing more debt, how can the Treasury continue to fund government activities? There are two ways. One is to use the money in the Treasury General Account (the Treasury’s checking account with the Fed), which had a balance of $578 billion as of July 28, 2021. The other is to use “extraordinary measures” that would add extra borrowing capacity for the Treasury. These measures, however, are expected to be exhausted by October or November 2021, according to the Congressional Budget Office.

What happens if the Treasury does run out of money? If it exhausts both the money in its checking account and the “extraordinary measures,” the consequences would be problematic and potentially catastrophic: delays of payments for government activities, a default on the government’s debt obligations, or both.

How to avoid a government default? Congress needs to raise or suspend the debt limit. Democrats can do this through a reconciliation bill without any Republican votes. But it seems that’s not the preferred approach as an increase of the debt limit was not included in the budget resolution passed in the Senate on August 11, 2021. Other options include passing a standalone bill or tying the debt limit to other legislation. In both cases, Republican votes are needed, and the timeline is most likely to be after Congress returns from recess in mid-September.

The pandemic and partisan disagreement, however, add uncertainties. Treasury Secretary Yellen mentioned that the pandemic made it harder to forecast government payments and receipts. And it’s possible that the “extraordinary measures” would be exhausted soon after the Congressional recess. On the other hand, it’s difficult to see Democrats and Republicans reaching a quick resolution as the issue is entangled with larger budget issues.

What does it all mean for investors? We’ve seen this issue surface before and drive short-term market volatility, but think investors should be on the lookout for something similar again. In the end, it’s unthinkable that the U.S. Treasury defaults, but investors should have this issue on their radar screen.