As has already been pointed out: though they may have possibly considered the idea of the games being connected at some point, it eventually became obvious that Xenosaga only shares some plot ideas/character similarities with Xenogears.

That being said, and I don't doubt I'll probably get flamed for this, but I find Xenosaga to be superior to Xenogears. Xenogears was a great game and all, but I found Xenosaga to have been handled more maturally and that the narrative was all in all better done in Xenosaga then it was in Gears (yes, even excluding Gears second disc, I still say the pacing and narrative of Xenosaga has, on a whole, been better). I certainly wouldn't mind seeing the two games connected, and in all honesty with the way episode III ends I actually kind of think they left it open for that possibility, but it's a very unlikely possibility.