Fiddler's "Automatic Authentication" feature doesn't work when server and client are on the same machine?

If IIS and the client are on the same machine, then a feature called "Loopback protection" is causing the authentication request to fail because your computer recognizes that it is authenticating to itself, and it is unexpected (due to the proxy).

You'll need to set DisableLoopbackCheck=1 as described here: http://support.microsoft.com/kb/926642