Is your SQL server setup to use Mixed Mode authentication? If not, then the
only way to do a datasource to an SQL server from SharePoint Designer is to
use SSO. SharePoint 2007 doesn't support Windows Authentication connections
to an SQL server unless using WSS 3.0 with the SQL instance located on the
same server as WSS. The only real workaround is to use either Microsoft
Single Sign on (SSO) or a set of non-windows SQL credentials.