The phrase plays on the idea of someone getting a big head and thinking too highly of themselves. It suggests that they are now enjoying the "fragrance" of their own inflated ego.
Here's how it might be used in a conversation:
* Friend 1: "Wow, I got a promotion at work! I'm going to celebrate!"
* Friend 2: "Don't get too excited, now. You're smelling yourself."
It's important to note that the idiom is usually used in a humorous or teasing way, but it can also be critical and derogatory depending on the context and tone.