It is possible to run the Silverlight build of Farseer Physics on Windows Phone 7. I am currently working porting my game
Snow Spill to WP7 as a Silverlight app. Also the original creator of Farseer Physics (Jeff Webber) is making a game for WP7 with Silverlight and Farseer Physics called
If you are going to share code between a Silverlight web project and a Silverlight WP7 project you should check out
Weather it's better to use Silverlight or XNA probably depends mostly on you and what your planning. If you know one better you might want to use that one. Keep in mind that it is possible to turn an XNA project into a Silverlight project using
silversprite, but I'm not aware of an easy way to convert in the other direction.