With over the air syncing for contact information enabled with your MM account on your iPhone, iTunes is not involved with syncing contact information in any shape, form, or fashion.
The Apple syncing software is not very good at telling you what it is going to do.
Under the Info tab for your iPhone sync preferences below Contacts with over the air syncing for contact information enabled on your iPhone, the following is provided.
+*Your contacts are being synced with your iPhone over the air from MobileMe.+*
*+Over-the-air sync settings can be changed on your iPhone.*+
Not sure how this can be any clearer at telling you what you have selected, and what iTunes is going to do or not going to do in regards to syncing contact information direct with the supported application on your computer via the iTunes sync process.
Sorry, but this was due to user error, not an iTunes or MM error.