* Federal Reserve starts meeting, eyes on possible tapering signal * U.S., European shares back off Monday's gains, bonds steady * Euro gains vs dollar after boost on upbeat German data * Bond yields slip; gold, oil fall after recent push By Richard Leong NEW YORK, Dec 17 (Reuters) - Financial markets were cautious on Tuesday as The U.S. Federal Reserve began a two-day policy meeting from which investors await possible signals on when it plans to start winding down its massive stimulus program.
The debate over when the Fed will begin to halt the flow of cheap dollars has dominated trading worldwide for months amid worries it could trigger a turbulent reaction from investors who have become all too used to the support.
"We know tapering is coming at some point. It depends on what they couple it with," said Arthur Bass, co-head of financial futures and options at Newedge in New York.
A majority of economists polled by Reuters expects the Fed to wait until March before it starts to scale back its $85-billion-a-month bond-buying program, but recent encouraging data from the United States, China and the eurozone have raised the chances on a move in January - or even this week.
"I put the probability of a tapering in December at 20 percent, January at 40 percent, and March at 80 percent," said Thomas di Galoma, co-head of fixed-income rates at ED&F Man Capital in New York.
On Tuesday, a better-than-expected report on U.S. home builder confidence and data suggesting low but stable price growth supported the view economic conditions are adequate for the central bank to taper.
The likely passage of a U.S. budget deal later week will remove an earlier hurdle the Fed had cited when it refrained from tapering in September.
The MSCI world equity index, which tracks shares in 45 nations, fell 0.2 percent to 393.41, giving back some of Monday's 0.6 percent gain.
On Wall Street, the Dow Jones industrial average was down 14.39 points, or 0.09 percent, at 15,870.18. The Standard & Poor's 500 Index was down 5.05 points, or 0.28 percent, at 1,781.49. The Nasdaq Composite Index was down 4.11 points, or 0.10 percent, at 4,025.41.
Europe's broad FTSEurofirst 300 index closed 0.8 percent lower at 1,248.30.
As the countdown to Wednesday's Fed decision began, the VIX index, Wall Street's fear gauge, pared gains to 16.15 after hitting a two-month high earlier in the session.
FED FOCUS Traders were also opting for caution in currency and bond markets. While a move to start trimming stimulus would be a symbolic signal from the Fed, its cautious approach has managed to convince markets that rate rises remain distant.
Prompted by some safe haven bids, U.S. 10-year Treasury yields, the benchmark for global borrowing costs, dipped 3 basis points to 2.846 percent, while 10-year German Bund yields were little changed at 1.824 percent.
Analysts at Societe Generale predicted a January start to tapering, but said "the economic case has already been made for pulling the trigger." The only reason to delay would be to give the FOMC the opportunity to strongly signal its intent, they said. "In either case - actual taper or signal of impending taper - we expect the 10-year U.S. Treasury yield to test 2.9 percent." The U.S. 10-year yield rose to 3.0 percent, a two-year high, in early September before falling to 2.5 percent in part due to the Fed's surprise move to not taper later that month.
Many analysts have been expecting the dollar to rise as the prospect of tapering strengthens.
On Tuesday, however, the greenback turned weaker against major currencies, erasing its earlier gains.
The euro edged up 0.06 percent against the dollar at $1.3769. The single currency bounced in and out of positive territory after Germany's ZEW business sentiment came in well above expectations and euro zone inflation came in stable.
The greenback slipped 0.4 percent against the yen at 102.60 yen.
Among commodities, Brent crude was down 99 cents, or 0.9 percent, at $108.42 a barrel as bets on a stronger dollar due to less Fed stimulus weighed.
U.S. crude futures fell 24 cents, or 0.25 percent, to $97.24. They wiped out their initial gains tied to expectations of data showing declines in U.S. crude inventories later this week.
Gold fell 1 percent to $1,228.60 an ounce, following back-to-back days of gains.
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