Hi Everyone,
I have come across this same exact problem with Outlook 2010 and connection to Office 365 for Hosted Exchange email. After hours of messing around with it i did find a solution.
On your computer that you have Outlook 2010 (and Office 2010), make sure that you have Office 2010 SP2 installed. I had 3 computers that would go through the autodiscovery process and to no avail would hang up constantly asking for the password. The Office 2010 SP2 comes in after a lot of other updates for Windows 7, Office 2010, etc... I have found on Windows 7 that Office 2010 SP2 comes in as an update by itself. So you may need some patience in getting all the updates done.
Well after i got Office 2010 SP2 installed the autodiscovery works just fine, and then only asks for the email address and password when you go into Outlook 2010, not during the autodiscovery