Is domain admin or server local admin rights enough and should hybrid authentication been enabled during MSDE setup?
I just tested it with server local admin rights, and it worked fine. The machine is a test box that's not on a domain, however, so your mileage may vary.
Hybrid authentication should have been enabled during MSDE setup for you to be able to use Windows authentication. If not, if it's SQL Server 2005, you can enable it with SQL Server Management Studio; right-click the server, choose "Properties", click "Security" and choose "SQL Server and Windows Authentication mode."
If you know the logon details for a member of the SQL 'sysadmin' group, you can use that instead.
Hope that helps.