It depends on whether it was said sarcastically or seriously. If the person speaking was serious it means that the other person now looks like everyone else. He doesn't stick out. He doesn't draw attention to himself by the way he is dressed.
If it was sarcastic it means the opposite. He draws a great deal of attention to himself by putting on that shirt.
Two men that one of them is a sheriff are talking , now imagine it, this is the context:Man 1:"you're going boating?(sarcastically)"
Sheriff:"I'm undercover"Man 1:"sure, Ray(Sheriff's name), you blend right in." Screen shot.
However I would say that "You blend right in." is irony and sarcasm. It means exactly the opposite of what is being said. It really means "You don't blend in at all, you are wearing clothes that will make you stand out. They are the worst possible clothes for someone who wants to be under cover."
This sort of irony is very common in BE and AE.
In this case blending in would mean to wear clothes that the average person would wear in that area. I can't see the picture but I am sure he is wearing clothes that make him look different from everyone else.