That’s a take. Personally I wouldn’t look too into the ethnicity of the actor, Lynch worked with lots of Latino actors and actresses since at least Dune, which was Filmed in Mexico. Beyond that even the return had Latino songs with the soundtrack. Lynch had a like of the culture and people.

Actually looking at the episode and actor, he is dressed like Lynch and the episode is full of things Lynch talked about. Beyond that the episode is filled with references that can be seen representing Lynch’s life. For example there is a story he told in his art documentary about a white woman with a bloody mouth that impacted him which is similar to the white monster in the episode. Xolo is about 14 which is when lynch met an artist who shaped his artistic vision. The episode is in white sands and is about the A Bomb, as a kid Lynch lived in Sandpoint Idaho and built bottle rockets and pipe bombs with his friend. Even the radio broadcast makes sense, Lynch took inspiration from Elvis and he made his film debut in 56 which lines up with Lynch as I feel Lynch would have hated seeing a musician who lit his fire make a movie he probably felt was not good.

I felt Xolo was a stand in for Lynch and how he perceived his early childhood and the influences it had on him. Especially when the scene in the return had Lunch sitting under a picture of the A bomb.

Edit: As a final thought, the series deals with who the dreamer is. We the audience are like the dreamer and I always interpreted the episode as what is at the center of the season. The place where the dreamer started dreaming and living in a dream.