Looks to me like Desktop Manager doesn't like the idea of syncing PIM data with the Hotmail data store in Outlook.
So, I'd do exactly what the error message suggests: create a local PST file in Outlook and tell Desktop Manager to sync data with that instead.
I will also admit that I do not use Hotmail connector and I have never personally seen this issue, but I've had my share of time wrestling with Outlook syncing.