I removed the "Create output file from stdout" (from the yui CSS file watcher and left it checked on the LESS file watcher) and it seemed to work. But I had to link to the yuicompressor.cmd and not the .jar file as mentioned in the links from LazyOne. I also had to uncheck the "Immediate file synchronization" on the LESS file watcher but needed it to be checked on the yui CSS file watcher.
Seems like its very tricky to get it to go from "LESS -> CSS -> CSS compressed" with only saving the .less file when editing, but with this setup it finally worked.