I feel like what you mean to say here is that because S-Ranks are outclassed that people aren't playing 1/3 (depends on how you view multi-mode and one-player mode) of the games available modes. It's totally fine that new weapons outclass S-Ranks. It's not fine that this in turn renders Challenge Mode useless.
This isn't really relevant, but Blizzard Needle is not something that is used in the regular PSO. I agree in general that Needle weapons are generally neglected, but that's because there's no Type version of them. I think this is a very easy fix.
I don't really think this is as you say among "3 major ones". Soul Booster would likely be the next combiner used for an item, but Ultimas issues are not related to lack of items in any way.
I don't think this is a necessarily a good solution. Launchers sort of suck so I'm not going to even address this.
There could definitely be a new Needle introduced to the game that's in the exact same vein as say Type SH/Shot relative to the S-Rank Shot. Same ATA, but you can add whatever special and hit with DTs. It could just be a standard drop somewhere outside of MotV and IDS as those are way busted for hunting. Ideally it would replace some regular no event drop because those tables are boring as hell and offer nearly nothing. Anything relating a GM redeeming for you is zzz.
None of Ultimas issues are directly related to the lack of items. Ultima has A LOT of weapons / items. An optimal Ultima inventory pretty much has no weapons in common with that of a vanilla or GC inventory.
The issues are the core systems related to gameplay and I agree that Challenge Mode serving no function is one of them. Changing the rewards is not too hard and is something I think should definitely be looked into. It's really hard to say what because in vanilla play CM adds an insane amount of replayability due to how the rewards function within Gallons Shop and the fact PDs are a little harder to come by. If Challenge Mode S-Rank clear times were made like 2 or 3 hours harder and allowed you to add hit to your weapons in 5 hit increments then it'd probably be more played than Normal Mode during non-events. This would be cool to me and also add a partial fix to the issue with DTs.