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"This report has been considered make or break in terms of Fed policy. That's too strong a word, but the idea is it would go a long way toward shaping expectations on tapering," said RBS senior economist Michelle Girard.
Anxiety has gripped markets, when it comes to discussions of tapering, and that talk has been kept alive by comments from a stream of Fed officials. The latest was Kansas City Fed President Esther George, the Fed's lone dissenter, and a hawk who believes the Fed should reduce bond purchases. In a prepared speech, George Wednesday said slowing the pace of bond buying would not mean tighter policy and would help break the dependence of financial markets on easy Fed policy.
Bond yields have been moving higher in anticipation of a possible pullback in the Fed's $85 billion bond purchase program on the view the economy is improving. That in turn has injected more volatility into the stock market and driven the dollar higher.
The Dow Tuesday was down 76 at 15,177, and the S&P 500 was off 9 at 1631. The 10-year Treasury yield rose to 2.14 percent.
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"Everybody's talking about how crucial this jobs number is," said one trader, quipping that Fed 'taper talk' has become the new market cliché, replacing 'kick the can' as an overused Wall Street phrase.
In the last several days, the level of uncertainty around the Fed has risen even more because the economic data is starting to look weaker, and that would keep Fed policy on hold. The ISM manufacturing report this week, in fact, showed the first contraction since November.
"In a way, policy makers almost introduced volatility around these numbers," Girard said. "They are trying to make the point it's not just one number."
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The ADP number has been sporadic in its usefulness as a gauge for the employment report. Girard said she is more concerned with the ISM nonmanufacturing report, released at 10 a.m. Wednesday, as it has an employment component that could be an important signal for the jobs report. She expects 175,000 jobs Friday.
"That (ISM) employment component does tend to track pretty well with the services number. We do look at that as a decent gauge," she said. "We've got the number very little changed from last month, 53 versus 53.1."
Other data Wednesday includes mortgage applications at 7 a.m., productivity and costs at 8:30 a.m., factory orders at 10 a.m. and the Fed's beige book on the economy at 2 p.m. Even before the U.S. data, financial markets will be tuned into Japan where the third leg of Prime Minister Shinzo Abe's stimulus program is expected to be announced.
Deutsche Bank chief U.S. economist Joseph LaVorgna said he is not expecting a big number from ADP, when it releases its report at 8:15 a.m. He expects 135,000 private sector jobs, compared to the consensus of 170,000. For the government jobs report, he expects 125,000.
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"I'm looking for a soft payroll report, so I'm looking for the same from ADP…If it surprises, it would have be something over 200,000," said LaVorgna. "The last three Mays don't look very robust. May in general is not a month where we've had big upward surprises for whatever reasons. May tend to disappoint on average."
LaVorgna said he expects markets to overreact to Friday's number no matter what, and the equity market is already acting as if it is being weaned from Fed easing. "Until the Fed tells us the economy's okay and it's not doing QE, or people see it in the data and the economy improves, we're going to be in this environment where people are going to be nervous about the training wheels not being there."
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He also expects the Fed to move to start tapering in September, earlier than many forecasts, which range into next year. "I don't think Friday's number matters that much. We're still a long way from September, and there's a lot of data between now and then," he said.
What Else to Watch
Brown-Forman and Hovnanian report earnings before the bell. Vera Bradley, Ascena Retail, Verifone and Francesca Holdings report after the close.