How to configure Fiddler to listen to localhost

I don't really understand your question. With IE, you have to go through special contortions to get http://localhost traffic to even go through Fiddler-- by default, WinINET applications (like IE) will not send localhost-traffic to proxies (like Fiddler).

Even if the traffic does go to Fiddler, Fiddler isn't going to "block" it unless you tell it to.

"Monitor all connections" has no impact here.

You should start by reading this thread, which explains what a HTTP CONNECT Tunnel is: https://groups.google.com/forum/#!topic/httpfiddler/RCkzE3HhhxY

Since you have enabled decryption, if you're not seeing any HTTPS traffic in Fiddler, you either have a Filter enabled (click Help > Troubleshoot Filters) or you have not configured Windows to trust the Fiddler root certificate and hence your clients are aborting the connection as soon as they see the (untrusted) Fiddler certificate.