Why do I need to "bypass" 169.254/16?

Solution 1:

It's on the exclude list because a 169.254/16 address is by definition not external to your network. A proxy server relays your requests to other networks. Proxy servers are much less common today than they used to be, but if you are using one, and you didn't have that exclusion, you could get some very strange results.

If you have the proxy enabled without exclusions, you run the risk of the proxy intercepting a request intended for a device on your network, and trying to relay it to the outside world. The possibility exists that the traffic would never reach its intended target on the local network. So the exclusion is telling the OS not to send traffic that should stay local to a proxy meant for external traffic.

I don't know of any reason why it would compromise your own computer's security either way. You can get rid of it, but I don't any advantage of doing so.