Windows authentication  has security holes in it, so Microsoft disabled it for
use in data  View. The userid and Password fields in the data source connection
are for SQL authentication only. To do Windows Authentication of the logged in
user you need to enable the Microsoft Single Sign-on service  and set it up with
Windows credentials that can be passed to the database.

"Security Holes" might be a little harsh - see
blogs.msdn.com/nunos/archive/2004/03/12/88468.aspx for a decent
description of the issues. It's written for pure ASP.Net, but the
underlying causes are the same since at its core SharePoint is a ASP.Net
app.

I looked at the BLOG and from what I saw that's a discussion of the limitations
of using Integrated security to access a back end database  and the double hop
problem that results. That wasn't what I was referring to. In ASP.net you can
use an Integrated Security connection string as long as you don't violate the
double hop. In SharePoint with the DataForm web  part you can't use Integrated
Security at all, even if you aren't violating the double hop problem. This was
possible in SharePoint 2003 with the DataView webpart and was also available in
BETA 2 of SharePoint 2007. The ability to use it was turned off after Beta 2
because the product team found that it could be exploited to compromise
security.