"Don't blow smoke

Just a little question from a Internet friend.
I think it has something to with just teasing someone, or leading a person astray without having bad intentions.

The latter. It's a way of saying "don't deceive me with an unrealistically optimistic analysis of what may be a serious situation."

A variation -- Don't pump sunshine up my skirt.

Or the foul weather variation -- Don't piss down my leg and tell me it's raining.