Running m365 setup --interactive is a shortcut into using the wizard and choosing to interactively use scripting.

However, when running m365 setup --interactive, the config key errorOutput is set to stdout.
This is not as it should be. This setting should be set to stderr in interactive mode.

When running m365 setup and choosing to interactively run scripting, the config key errorOutput remains correctly set to stderr. So the behavior only occurs when running with the flag --interactive.

Reason

This behavior is due to a PowerShell preset:

if (pid.isPowerShell()) {
  Object.assign(settings, powerShellPreset);
}

This PowerShell actually only makes sense in scripting mode, when you want the errors in the regular output stream, so you can catch them and work with them, in combination with printErrorsAsPlainText=false.